A LEGALFRAMEWORKFOR IMPACT
Sustainability impact ininvestor decision-making

A LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSFOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A.		 INVESTING FORSUSTAINABILITY IMPACT
1. What is investing for sustainability
impact?
2. Investing for sustainability impact:
goal certainty, assessment of impact
and understanding an investor’s
contribution
3. What portion of global assets undermanagement is currently subject toinvestment approaches involving
investing for sustainability impact?
4. In what ways do people want theirassets invested to bring aboutsustainability impacts?

B. THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS INVESTINGFOR SUSTAINABILITY IMPACT
1. Methodology

JURISDICTION REPORTS
Australia
Brazil2. Investing for sustainability impact:
different legal regimes but common
themesCanada3. Investing for sustainability impact ineleven jurisdictions – summaryof findings

European Union

4. Do existing market features create a riskthat sustainability factors are given
insufficient weight by investors incomplying with legal duties?

C.		 AREAS FOR LEGAL REFORM

2

		ANNEXES –ChinaFranceJapan
Netherlands
South Africa
United Kingdom
United States

1. Potential impediments to investingfor sustainability impact investment
approaches

GLOSSARY

2. Reform options

REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFOREWORDSCONTENTSFOREWORDSINTRODUCTION

The Generation Foundation

ACKNOWLEDGEMENTS

Al Gore and David Blood
When we founded Generation Investment
Management in 2004, the concept of sustainable
investing was widely considered an admirable but
fringe approach. Now, 17 years later, sustainable
investing has not only become mainstream, but
is recognised as a mark of prudent investment
practice. Pioneering analyses like the ‘Freshfields
report’ in 2005, and Fiduciary Duty in the
21st Century helped drive this transition bychallenging accepted wisdom about investors’
duties and helping them re-envision their roles.
And in the intervening years, environmental,social and governance issues have introduced bothnew risks and new opportunities across investors’
portfolios, awakening many to the material costsof failing to incorporate these values, as well as
the prospects for using ESG analysis to better
identify new, fast-growing business trends.
Yet, too many investors still approach ESG
investing from a defensive posture. We consider
that risk management alone is not enough.

3

Investors should make decisions on the basisof risk, return and impact in order to take fulladvantage of the opportunities provided by what
we call the Sustainability Revolution.
This first-of-its-kind report, commissioned by
The Generation Foundation, PRI and UNEP FI,
considers the role of the investor as an active
agent in shaping the world around us, rather
than as a spectator betting on the side lines. Thisdetailed, global legal analysis demonstrates thatinvestors should feel empowered to set impact
goals and measure progress against them. It also
highlights what must change to ensure that therules that govern our financial system foster atruly sustainable economy.
We hope that investors, intermediaries,
policymakers and regulators will read this reportas a call to action to build a better financial
system. We do not have another 17 years to wait.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFOREWORDSCONTENTSFOREWORDSINTRODUCTION

United Nations Environment Programme (UNEP)ACKNOWLEDGEMENTS

Inger Andersen

EXECUTIVE SUMMARYThe Sustainable Development Goals and the Paris
Climate Agreement are our best chance for not
only a livable but also a brighter future. Reachingthese goals requires an updated financial systemthat is fit for purpose – one in which assessing
and accounting for the sustainability impact
of investment decision-making is a core part ofinvestment activity. This groundbreaking reportprovides a much-needed roadmap.
To date, despite significant advances, capital
markets continue to operate beyond sustainability
boundaries. It is clear that we need to change. The
science cannot be disputed. Business-as-usual ishaving a devastating impact by propelling climatechange, destroying nature, and raising pollution
levels. The triple planetary crisis is not only being
exacerbated by inequality, but it is also likely tofurther deepen inequality. At the same time, weare seeing a rapid awakening in some segmentsof society, and in particular among young people,
demanding better from business and government.
Capital markets must treat all these risks as theserious, systemic risks that they are.
Investing and collaborating for sustainability
impact is no longer optional. It is essential for
financial stability, for managing systemic risks,and for protecting the world for our children. It
is now clear that investors can and must consider
how these issues affect their goals and theirimpact on the real world.

4This report offers a blueprint for how to better alignthe provision of finance with sustainability objectives,
looking at existing opportunities and obstacles.
Taking account of the vast regulatory landscape,this report identifies areas of reform to fostera more supportive environment for investors
to integrate impact into investment decisionmaking. For capital markets to significantly help
solve the big societal issues we face requires
regulatory frameworks that move beyond merely
integrating ESG issues where they are financiallymaterial, towards more effective integration ofsustainability impact. This requires determined
and collective action from investors, policymakers
and regulators, unified in the journey to achieving
the goals of the Paris Agreement and the SDGs.
As stewards of the common good, it is vital that
all actors steer our world onto a more sustainable
path. A Legal Framework for Impact highlights
paths forward to strengthen the financial system
so that impact is systematically managed by
all investors – a pre-requisite for meeting oursustainability goals. The health of people andplanet, as well as of investments across the world,
depend on investors and policymakers engaging
with the issues addressed in this report.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFOREWORDSCONTENTSFOREWORDSINTRODUCTION

Principles for Responsible Investment (PRI)ACKNOWLEDGEMENTS

Fiona Reynolds

EXECUTIVE SUMMARY

Responsible investment has come a long way overthe past few decades as investors have started
to recognise the importance of ESG issues totheir investment decisions. This has been driven
in large part by the Freshfields report of 2005
which concluded that investors are permitted andarguably required to integrate ESG factors into
their analysis, and the subsequent UNEP FI, PRI
and Generation Foundation programme: Fiduciary
Duty in the 21st Century, which determined that ESG
factors must be considered for investors to meettheir fiduciary duties.
Today investors are starting to look beyond
the impacts of ESG risks on their portfolios tounderstand the impacts their portfolios have on
the real world around them—the world theirbeneficiaries live in and will ultimately retire
into. They are beginning to assess, measure andmanage the real-world sustainability outcomes of
their investment activities.
As it currently stands, many investors still do
not systematically consider their role in shaping
sustainability outcomes. But this mode ofoperating, without considering the positive andnegative impacts of investments on people andthe planet, will not be sufficient for a sustainableeconomy. A gap has emerged in the ways ofworking we need in responsible investment tominimise harms and deliver on increasingly
urgent environmental and social needs.

5

The Legal Framework for Impact project was launchedby PRI, UNEP FI and The Generation Foundation
to address this gap. This groundbreaking reportshows how investing for sustainability impact isrelevant for all investors, and that they will likely
have an obligation to consider doing so where it
can help in pursuing their financial objectives. It
lays the foundation for the financial policy reforms
we need to reorient investors and, through them,markets and economies towards net zero andinclusive, sustainable economic growth.
The clock is ticking on our opportunity to achieve
the Sustainable Development Goals and align with
the Paris Agreement and it is clear that we needto move faster and go further. PRI, UNEP FI and
The Generation Foundation are launching a 3-year
work programme to translate the findings of thereport into jurisdiction-specific engagement with
policymakers, lawyers and investors on investingfor sustainability impact, so we can work together
to accelerate change.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

A paradigm shift towards investing forsustainability impact is upon us. This is a newfrontier that we must navigate together.

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFOREWORDSCONTENTSFOREWORDSINTRODUCTION

Freshfields Bruckhaus Deringer LLP

ACKNOWLEDGEMENTS

Georgia Dawson and Edward Braham

EXECUTIVE SUMMARY

We are proud to have been asked to produce
this report, in collaboration with firms in ourStrongerTogether network. The report addresses
the pressing issue of how far institutional
investors are legally required or permitted toinvest for sustainability impact, covering theworld’s major investment hubs.
The report sets out the law as it stands andindicates the direction of travel around the world. It
also lays out policy options that facilitate investingfor sustainability impact. It should therefore help
investors, business leaders and policymakers.

The firm’s 2005 report on institutional investor
duties for the UNEP FI has been highly influential
in sustainable finance practice and regulation
around the world. It also affected the firm’s own
thinking and contributed to our decision in 2007
to be carbon neutral, a key milestone towards thelarger goal of net zero and delivering on broader
sustainability goals.
More than fifteen years on, with global society
increasingly appreciating the importance ofsustainability issues and their interdependencewith finance and economic activity, the questions
addressed in this report have never been moreurgent. We hope that this report contributes to abrighter future for the world.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

6Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGINTRODUCTIONCONTENTSFOREWORDSINTRODUCTION

This report is about achieving the goals wevalue. It is about how institutional investment
management can help with that, and it is about
how the law supports the process.

The goal most associated with institutional
investment management is earning a financial
return. People and organisations depend on
institutional investors to generate the financethey need to sustain themselves. Earning afinancial return is a valued goal.
But earning money is obviously not the only goal
we have for our lives or for our world. It exists
alongside broader goals concerning the quality ofthe social and natural environment we inhabit, orat least its sustainability. These too are valued goals.
There may have been a time when it was possible
to approach the goal of earning a financial returnlargely in isolation from the others. In reality,
however, financial and economic systems arepart of wider social and natural ecosystems, thehealth of which is vital to broader goals. Financial
and economic systems can help these ecosystems
flourish, particularly in their social dimension.
However, they also depend upon and canadversely affect them. They can both strengthen
and undermine the systems on which they rely.
The impact of laws on how people behave depends,
among other things, on what those laws say, butalso how they are understood and followed inpractice. Both are affected by prevailing beliefs
about the way things are. If it has been assumed
that investment could be approached as no morethan an exercise in generating financial return,detached from its social and natural environment,
then it is not surprising if laws and the way they
have been understood have reflected that.1
1

7

But if it was once possible to approach the goalof earning a financial return in isolation fromother valued goals, that time is not now. Theinterdependence between financial and economic
activity and the systems on which it relies – andon which achieving broader goals depend – isever clearer.

the law does not require or permit that, and to
the extent the political processes mentioned above
determine that it should, the report also looks atwhat options might be available to policymakers.

Because of that, there has been an increasing focus
on the financial community as a source of solutions
and on the question of whether finance law needs
to change to achieve sustainability-related goals. At
least in part, that question needs to be answered
through political processes. The challenges are
systemic, and finance is part of the system, so
clearly finance has a role. However, solutions also
involve looking more widely at consumption andproduction activities and facing questions of intergenerational and inter-group justice.

impact is, how extensive it is and growing
evidence that people want their money managed
so as to have positive sustainability impacts.

It is therefore not the purpose of this report toanswer the question of what ought to happen.
Rather, the report looks at 11 jurisdictions
that represent a cross-section of investment
hubs, cultures and legal traditions, including
the world’s largest centres of investment
management. It asks whether the law as it
stands in those jurisdictions requires or permits
institutional investors, specifically pension andmutual funds and insurers and their investment
managers, to tackle sustainability challenges indischarging their legal duties and exercising theirdiscretions: does the law do so in order to enable
them to realise a financial return, and does it doso in a way that allows them to treat resolving
some sustainability challenges as an end in itself ?
This is, essentially, what is meant in this report by‘investing for sustainability impact’. To the extent

The report is, then, in three parts following theexecutive summary.
• Part A looks at what investing for sustainability• Part B addresses the question of whether thelaw in the jurisdictions covered requires or
permits investing for sustainability impact,
considering both the ‘black letter’ of the law
and circumstances that are relevant to the way
in which it is applied.
• Part C discusses options available topolicymakers to facilitate investing forsustainability impact.
As well as focusing on the goals investors are
required or permitted to pursue, a key theme inthis report is cooperation. Many sustainability
challenges are essentially the result of problems
caused by multiple actors and require collective
action to resolve them. The outcome of acollective action is the product of a multitudeof individual acts. However, those acts are notatomised. They are trained on a common goal. In
investment markets, one way of achieving thissort of coordination is through investor coalitions.
Policy intervention is another.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Mark Carney, Value(s): Building a Better World for All (William Collins 2021); David Rouch, The Social Licence For Financial Markets: Reaching For The End And Why It Counts (Palgrave Macmillan 2020).

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGINTRODUCTIONCONTENTSFOREWORDSINTRODUCTION

In a sense much has changed and yet little haschanged since we started writing this report.
The sustainable finance landscape has developed
at dizzying speed, with a host of sustainabilityrelated initiatives and commitments from major
financial institutions, and an acceleration ofwork among governments and NGOs. Much of
it is relevant to this report and is mentioned in
it. We had to hit a moving target. And yet, theunderlying sustainability challenges remain,and in some cases are growing. The questions
addressed by this report are therefore as pressing
as ever.
We are enormously grateful to the considerable
number of people who have contributed toproviding answers, both the jurisdictional legal
teams in our offices and the members of ourStrongerTogether network who have prepared
the legal memoranda in the annexes and allof those who have commented on and helpedin drafting it, whose names are included in
the acknowledgements that follow. We would
especially like to thank Philip Richards, Annabel
Sykes and Mark Kalderon for invaluable assistanceand challenge and the core team who havesupported the work: Emma Rachmaninov, Shona
Hughes-Daly, Olivia Carrington, Gabriela Rocha

8

Gomes Strieder and Angela Evans. We are grateful
to our clients, the UNEP FI, the PRI and theGeneration Foundation for asking us to prepare
the report and to the partners of Freshfields
Bruckhaus Deringer LLP for having made sucha generous commitment to it and given us theopportunity to undertake this important work on
their behalf.
The concern of this report is a collective global
challenge and, appropriately enough, meetingthe challenge of preparing it, particularly during
the Covid-19 pandemic, has been very much acollective global exercise.
David Rouch and Juliane Hilf

July 2021

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGACKNOWLEDGEMENTSCONTENTSFOREWORDSINTRODUCTION

We are grateful for the support and assistanceof experienced industry leaders in a variety ofjurisdictions, senior representatives of leading
financial institutions and NGOs with expertiseon a broad range of relevant subject areas andrelevant jurisdictions. Their insights have been
invaluable. We would like to thank:

Jesica Andrews, Julie Ansidei, David Atkin, Elise
Attal, Clara Barby, Stephen Beer, David Blood,
Nicole Bradford, Vanessa Casano, Jeremy Cooke,
Xander den Uyl, Grace Eddy, Maria Elena Anker,
Rebecca Elliott, Joanne Etherton, Nathan Fabian,David Farrar, Gerard Fehrenbach, Elodie Feller,
Jess Foulds, Rob Gardner, Michael Garland, Sean

Gilbert, Esther Gilmore, Jeffery Gordon, Al Gore,
Iris H Chiu, Gregory Hershman, Oliver Hunt,
Daniel Jackson, Carlos Joly, Martin Jonasson,
Ryan Klausing, Libby Klein, Kelly Krauter,
Claudia Kruse, Laxmi Kumar, Richard Lacaille,
Ben Leblique, Steve Lydenberg, Susan Mac
Cormac, Mark Manning, Alexander Marshall,Will Martindale, Edward Mason, Mike McCreless,Hiro Mizuno, Renosi Mokate, Olivia Mooney,
Robert Nash, Alina Neculae, Chris Newton, Geoff
Nicholas, Stuart O’Brien, Colleen Orr, Alison
Paton, Margarita Pirovska, David Pollard QC, Rema
Rajeswaran, Fiona Reynolds, Jake Reynolds, Philip
Richards, Simon Rowse, Lesley Russell,

Elsa Savourey, Keith Scott, Omar Selim, Marcelo
Seraphim, Kazuyuki Shigemoto, Annabel Sykes,
Di Tang, Tom Tayler, Montgomery Taylor, Tara
Tilbury, Michael Torrance, Roger Unwin, Eric
Usher, Margaret Wachenfeld, Steve Waygood,Kong Wei, Shelagh Whitley, Clare Wilkinson
and Daniel Wiseman.
At Freshfields, we would like to thank Olivia
Carrington, Jonas Dereje, Oliver Dudok van Heel,Angela Evans, Gabriela Rocha Gomes Strieder,
Shona Hughes-Daly, Mark Kalderon, Daniel
Klingenbrunn, Geoff Nicholas andChristopher Simpson.

We are also very grateful to the specialist authors of the jurisdictional reports.
Jurisdiction

Firm

Authors

Australia

Corrs Chambers Westgarth

Anton Bobenko, Michael Chaaya, William Chaffey, Kon Mellos, James Whittaker and Phoebe Wynn-Pope

BrazilMattos Filho

Flávio Barbosa Lugão, Fernanda Basaglia Teodoro, Tábata Boccanera Guerra de Oliveira, Vitória de Assis Pacheco Morais,
Gabriel de Freitas Queiroz, Eduardo Cezar Delgado de Andrade, Anália Cristina Ferreira Brum, Júlio Figueiró Melo,
Renata Fonseca Zuccolo Giannella, Juliana Furini de Vasconcellos Puntel, Juliana Gomes Ramalho Monteiro, Luis Eduardo
Kussarev Al-Contar, Ary Oswaldo Mattos Filho, Maria Luiza Miranda Geraldi, Vinícius Paula Castro, Lina Pimentel Garcia,
Isabela Sartori, Bárbara Gabriel de Vasconcelos Silveira, Marcela Venturini Diorio and Gabriel Zampieri Ferreira Batista

CanadaStikeman Elliott LLP

Nicholas Badeen, Stuart S. Carruthers, Christopher D. Lofft, Stewart Sutcliffe and Natasha vandenHoven, with thanks to
Sagar Darar and Alexandra Ghelerter

China

Freshfields Bruckhaus Deringer LLP

Amber Liu, Yuxin Shen and Wang Zhe

EUFreshfields Bruckhaus Deringer LLP

Markus Benzing, Wessel Heukamp, David Jansen, Daniel Klingenbrunn, Jadwiga Loiko, Bastian Schuster andDavid Schwintowski

FranceFreshfields Bruckhaus Deringer LLP

Marc Perrone

Japan

Kanagawa International Law Office

Shinsuke Kobayashi

Netherlands

Freshfields Bruckhaus Deringer LLP

Marit Balkema, Michael Broeders, Igor Dovgaliouk, Hakan Gargili, Charlotte Kriekaard, Maxine Lemstra, Sharon Sloof,
Barbara Slooter and Marco Vogels

South Africa

Bowmans

Carmen Bradfield, David Geral, Richard Griffin, Ryan Kitcat, Wandisile Mandlana, Deirdre Phillips, Christine Rodrigues,
Kirsten Serrurier and Bright Tibane

United Kingdom

Freshfields Bruckhaus Deringer LLP

Edmund Barber, Olivia Carrington, Gareth Davies, Rachel Duffy, Lisa Eger, Morag Elwis, Angela Evans, Laura Feldman,
Abdullah Geelah, Tom Howard, Shona Hughes-Daly, Gregory King, Priti Lancaster, Charles Magoffin, Martin McElwee,
Emma Rachmaninov, Tom Rhodes, Christopher Simpson and Annabel Sykes

United States

Freshfields Bruckhaus Deringer (US) LLP

Elizabeth Bieber, Melina E De Bona, Lori Goodman, Timothy Harkness, Lauren Kaplin, Hannah Khalifeh, Brian Lewis, Sam
Lowenstein, Laurie Morgan, Travis Panneck, Jerome Ranawake, Brian Rance, Jordan Salzman, Elvira Sihvola, Altin Sila,
Aaron Voloj Dessauer and Timothy Wilkins

9

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGEXECUTIVE SUMMARYCONTENTSFOREWORDSINTRODUCTION

KEY MESSAGESWhat is the issue?

Human wellbeing relies on the sustainability of
key environmental and social systems. In somecases, that sustainability is under threat. This ispartly the result of economic activity and, if notaddressed, will create risks to economic systems
and all who rely on them. Solutions require
action from individuals and institutions, butalso a system-wide response: collective action,
coordination and cooperation.
Investment is part of and depends on thesesystems to generate financial returns. So, there isa question whether the investment sector needs
to be more focused on addressing sustainability
challenges, even if its only motive in doing so is toachieve its own financial purpose.
What is the solution?

Investment activity within the scope of ‘investingfor sustainability impact’, or ‘IFSI’, has been
identified as a way for the investment sector to dojust that. Investors are increasingly focusing on
their impact. Clarity on the legal framework fordoing so is therefore of key importance.
IFSI describes any investment approach where
investors intentionally seek (through the activities
they finance or otherwise) to influence what
investee enterprises and third parties do inassessable ways that address sustainability
challenges. It therefore differs from many
existing forms of sustainable investing which
focus on integrating sustainability factors into
investment decisions but do not necessarily
involve intentional influence of this sort. It
addresses a similar issue to current work on
corporate purpose, but from the point of viewof investors. Growing evidence suggests that
this more purposeful investing is what many
individual investors want from those managing
their investments.
10

ACKNOWLEDGEMENTS

The aim of our project has been to establish
whether the law currently requires or permits IFSI
(looking at the main categories of asset owner andtheir investment managers in 11 jurisdictions),
and to identify options for policymakers wishing
to facilitate IFSI.
Does the law require or permit IFSI?

To a significant extent it does although, given
the diversity of jurisdictions and investor
types covered, there are all sorts of variations.
Financial return is commonly the primary goalof institutional investors, so the situation ismost clear where a sustainability risk bears on
investors’ duties to pursue financial goals. Here,
where sustainability impact approaches can beeffective in achieving an investor’s goals, theinvestor will likely be required to consider using
them and act accordingly. However, there aredifferences of understanding and uncertainties.
Cases where investors can pursue sustainability
goals for their own sake in parallel with financial
goals are more limited, but there are instances inmost jurisdictions, usually subject to prioritisingfinancial goals.
Whether institutional investors conclude inpractice that IFSI is legally required or permitted
will also depend on the circumstances in which
they act; for example, an IFSI approach might, inprinciple, be attractive in a given case, but there
could be too much uncertainty as to outcome or
cost to adopt it. In addition, prevailing market
features, such as commonly used performancebenchmarks, may reduce attention tosustainability factors in investment practice.

Facilitating IFSI: what can be done?

Since the behaviour produced by legal rules
depends on what those rules say and thecircumstances in which they are applied,
we identify options for policymakers
wishing to facilitate IFSI that tackle both.
They are possibilities for consideration, notrecommendations. They do not cover wider
interventions in primary economic activity or
fiscal policy (which can also fundamentally affectinvestment decisions), although policymakers willundoubtedly want to consider these.
Options include:• changing investors’ legal duties and discretions

and how they are understood in ways thatfacilitate IFSI (such as allowing the pursuit ofsustainability goals as long as financial return
goals are prioritised, and a presumption infavour of investor collaboration in tacklingsustainability challenges);

EXECUTIVE SUMMARY
A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES• changing the circumstances in which rules areapplied in three broad ways: (i) building theenabling environment for IFSI (eg by ensuring
the availability of decision-useful corporate
sustainability data); (ii) promoting in-depth
research to establish whether market features(such as prevailing investment theory, the terms
on which investment managers are appointed
and stock lending to short sellers) may lead
investors to underweight sustainability
factors and steps to address this if so; and (iii)
strengthening market discipline (eg throughproduct labelling and governance rules forsustainability-branded products and ensuringthat investors’ sustainability preferences areproperly reflected in the investment process).

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGEXECUTIVE SUMMARYCONTENTSFOREWORDSINTRODUCTIONEXECUTIVE SUMMARY
This report is about achieving the goals wevalue. It is about how institutional investment
management can help with that, and it is about
how the law supports the process. It concerns anapproach to investing which is orientated towards
addressing sustainability challenges either toachieve financial investment goals, or in addition
to those goals.
In this report, that approach to investing iscalled ‘investing for sustainability impact’, or‘IFSI’. IFSI is not a legally defined expression andis not used in this report as a term of legal art.
Nor is it intended to add to the alphabet soup of
the sustainability world. Instead, it serves here
as no more than a ‘conceptual net’ to catch,broadly, any activities that involve an investor
intentionally attempting (through the activities it
finances or otherwise) to influence the behaviourof investee enterprises and other third parties
in assessable ways that can help to achieve
overarching sustainability outcomes – outcomesconsistent with the social, environmental,
economic and human rights goals suggested byvarious international instruments such as the Paris
Agreement and the Sustainable Development Goals.
1.

What is the issue?

Human wellbeing relies on the sustainability of
key environmental and social systems. In somecases, that sustainability is under threat. This ispartly the result of economic activity and, if notaddressed, will create risks to economic systems
and all who rely on them. Solutions require
action from individuals and institutions, butalso a system-wide response: collective action,
coordination and cooperation.
The investment sector is part of and depends onthese systems to generate financial returns. So,

1
2

11

ACKNOWLEDGEMENTS

there is a question whether it needs to be more
focused on addressing these challenges, even if
its only motive in doing so is to achieve its own
financial purpose.
Sustainable finance and investment activity has
grown significantly, driven among other things byopportunities created by sustainability transitions
and a desire to protect financial asset value.
The need for investor attention to sustainability
factors is ever-more pressing. However, it isunclear how far activities to date have helped inachieving overarching sustainability outcomes.1
Some of the main forms of sustainable,
responsible or ESG investing tend to focus on
investing in enterprises considered as having a
positive sustainability profile and avoiding thosethat are not. These investment approaches may
have an influence that is aligned with overarchingsustainability outcomes and could be used as partof an IFSI strategy. However, in isolation, they do
not involve the investor intentionally seeking tobring about assessable changes in the behaviourof investee enterprises and others.
2.

What is the solution?

of investment. That said, the two issues are notentirely separable. Consequently, we have needed
to assume for this project that IFSI investment
approaches can indeed contribute to achieving
overarching sustainability outcomes and help
realise institutional investors’ investment goals,
financial or otherwise.
IFSI essentially addresses the same issue as
current attention to corporate purpose, butfrom the point of view of investors: what is the
purpose of economic activity and how does it
relate to the wellbeing of people and planet?
Questions of investment purpose and corporate
purpose both concern what is valuable, not justfinancially but also in terms of outcomes for thesocial and natural environments on which people
depend. IFSI approaches these questions fromthe perspective of investors, corporate purpose
from that of the companies in which they invest.
In answering them it is helpful to recognisethat they converge on similar ground. Growing
evidence suggests that this more purposefulinvesting is what many individual investors wantfrom those who manage their assets (see Part A.4).

EXECUTIVE SUMMARY
A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Investor activities within the scope of IFSI would
involve seeking to bring about change in just thatway. Investors are increasingly focusing on theirimpact. Clarity on the legal framework for doing
so is therefore of key importance.
The purpose of our project has not been to
test whether IFSI investment approaches canbring about change, although it seems credible.
Rather, the principal aim has been to reach aview on the basic question of how far the law in
key jurisdictions2 currently requires or permits
investment approaches that fall within IFSI, as
part of or in addition to the usual financial goals

See for example, World Economic Outlook: A Long and Difficult Assent, International Monetary Fund, October 2020, Chapter 3.
The 11 jurisdictions covered represent a cross-section of investment hubs, cultures and legal traditions, but include the world’s largest centres for investment management.

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3.

What are the key characteristics of IFSI?

The key feature of IFSI is the sort of goals an
investor is pursuing (see Part A.1). IFSI will
always involve an investor intentionally using
its powers to try to bring about assessable
behaviour changes among business enterprises orpolicymakers aligned with achieving overarchingsustainability outcomes. This includes, but is not
limited to, investment funding for sustainabilityfocused projects. Influence could be direct, or
indirect through engagement with others, suchas scientific or industry bodies. In this report,changes of this sort targeted by investors arecalled ‘sustainability impact goals’. Targetedchanges can involve a reduction in negative or an
increase in positive impact, or both.
Sustainability impact goals could take many forms
ranging, for example, from a change in a businessprocess to reduce its negative sustainability impact(such as polluted water emission levels), or thelaunch of a new enterprise that involves a positive
sustainability impact (such as developing battery
technology), through to higher-quality enterprisesustainability disclosures to inform investment
decisions and impact-oriented stewardship andpolicy engagement. Goals could also involve
steps to achieve better policy alignment withinternational sustainability commitments.
Two levels of impact. Investors engaging in IFSI

are therefore concerned with two sorts of related
sustainability impact.
First, the impact on social and environmental
sustainability of business enterprises, and the impact
of policymakers and other third parties on theoperating environment for enterprises and investors.
Second, the influence, or impact, thatthe investors themselves can have on thesustainability impact of enterprises, policymakers
and other third parties.

impact, as noted previously, by investing inenterprises that have a positive sustainability
profile and avoiding those that do not. By
contrast, IFSI concerns both sorts of impact. It
involves an investor recognising that to achieve its
objectives it needs to pursue sustainability impact
goals by influencing the sustainability impact ofothers (see Diagram below). What is often called‘impact investing’ would be an example of this,but IFSI covers a much broader range of practices
than has typically been the case with impact
investing to date.
Ways to pursue impact. Investors can pursue

sustainability impact goals in various ways.
However, the project has looked at the legal
position on investors’ use of investment
powers, stewardship activities and public policy
engagement. Which of these it is appropriate
for an investor to deploy in pursuing a given
sustainability impact goal, and in what
combination, will depend upon the precise
circumstances, including the sustainability goalconcerned and asset class. Legal attention has
hitherto tended to focus on the use of investment
powers. However, in public markets, there is
likely to be a particular role for stewardship andpolicy engagement, especially when undertakencollectively. Indeed, for the growing portion of
global assets under management (AuM) committed
to passive investment strategies these may
effectively be the only means of influence available.

4.

The purpose of IFSI: instrumental IFSI and
ultimate ends IFSIThe key defining feature of IFSI is the investor’s
purpose. IFSI will always involve trying to
influence the behaviour of third parties in waysaligned with overarching sustainability outcomes,
but for what reason?
One reason will be protecting or enhancing thefinancial performance of the investor’s portfolio.
In particular, targeting sustainability impact
goals might be intended to help support thesustainability of economic, environmental andsocial systems on which financial value depends,
the declining sustainability of which could (aswith climate change) create systemic risks toinvestors’ ability to achieve their financial goals.
Another case might involve seeking an increase invalue through working with one or more investee
companies to address a given sustainability
challenge. However, an investor might also pursue
sustainability impact goals for reasons not directly
connected with its financial return objectives,
including treating impact goals as worthwhile
ends in themselves.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY
A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Investors and investment relationships
covered. The concept of IFSI is not confined toany section of the investment market or any
asset class (so would cover holdings of debt
instruments, funds and private equity interests aswell as publicly traded shares).

Some forms of sustainable, responsible, or ESG
investing essentially focus on the first sort of
12

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGEXECUTIVE SUMMARYCONTENTSFOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

This report makes a key distinction between two
kinds of IFSI based on this difference(See Diagram).

EXECUTIVE SUMMARY• Instrumental IFSI is where achieving

the relevant sustainability impact goal is‘instrumental’ in realising the investor’s
financial return goals.

A. INVESTING FORSUSTAINABILITY IMPACT• Ultimate ends IFSI is where achieving the

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSI

relevant sustainability impact goal, and theassociated overarching sustainability outcome,is a distinct goal, pursued alongside theinvestor’s financial return goals, but not wholly
as a means to achieving them.

C. AREAS FOR LEGAL REFORM

The goals of ultimate ends IFSI can be broader
than instrumental IFSI. However, that does notmean that they would necessarily be inconsistent
with investors’ financial goals, nor that theyshould take priority over them. It simply meansthat an investor’s decisions are partly motivatedby seeking to achieve a sustainability impact goalfor reasons other than achieving the investor’s
financial goals.

ANNEXESGLOSSARY
REFERENCES

Clarity on this question of purpose is importantbecause of how the purpose of an activity
influences the way it is undertaken and its
outcomes, including which legal rules are relevant
and how they are applied.
5.

How feasible is it in practice for investors to
set and pursue sustainability impact goals?

It is not the purpose of this report to answer thisquestion. However, it is relevant to the legal analysis.
Investors’ capacity to define sustainability
impact goals, assess progress towards them andunderstand their own contribution is developing
but is more advanced in some areas and for some
aspects of sustainability than others (see Part A.2).
This presents challenges for investors, not leastin terms of expense. These challenges affect what
investors can and should do. That is because what
legal duties and discretions require or permit does
not just depend on what the relevant rules ‘say’
13(their ‘black letter’) but also the circumstances inwhich they are applied. Current challenges should
reduce as market understanding, methodologies
and practice develop and relevant, consistent data
become more available. However, for now they
may lead investors to focus on areas where theground is more certain, extending their activities
as this ‘market infrastructure’ evolves.

6.

What level of global AuM is currently
subject to IFSI?

The concept of IFSI has not so far been used todefine AuM research, so there is no easy answer tothis (see Part A.3). An investor could engage in IFSI
in various ways. A proper answer would therefore
require a qualitative assessment; just because
assets appear to be subject to an IFSI approach
does not necessarily reveal much about its rigour
or outcomes.
Management of the bulk of global institutional
investor AuM (approximately $ 110tn) does not
Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGEXECUTIVE SUMMARYCONTENTSFOREWORDSINTRODUCTION

currently appear to involve IFSI. Nonetheless,with important caveats including those justmentioned, a significant and growing proportion
may be subject to IFSI at some level. This is based
especially on the activities of investor coalitions
whose activities appear to involve to some extent
pursuing sustainability impact goals. Membersof the NetZero Asset Managers Initiative and NetZero Asset Owners Alliance control AuM of $ 43tn
and $ 6.6tn of AuM respectively.
The increasing concentration of AuM with anumber of large investment management firms
potentially gives them a particularly important rolein the development of IFSI investment approaches.
7.

Does the law require or permit IFSI?

Investment markets involve a multitude ofdifferent operators all of which may influence
how far investors engage in IFSI. However, at its
core, the answer to the question posed for our
project depends on legal rules applicable to two
categories of investors: asset owners and theirinvestment managers. Our project has therefore
focused on these and, in the case of asset owners,on the three largest subcategories by global AuM:
pension funds, mutual funds and insurancecompanies (Asset Owners).
The legal duties and discretions that apply
to Asset Owners in managing their assets are
key to the analysis. But what these require or
permit is not just relevant to them; it also shapes
the obligations and discretions of investment
managers and others who assist Asset Owners inmanaging their assets. For example, to discharge
their own legal duties, investment consultants
need to understand the Asset Owner’s duties anddiscretions to decide how best to advise. In otherwords, there is a legal ‘cascade effect’ from Asset
Owners to all those who directly or indirectly
provide services to them.

14

7.1

High level conclusions

There is no single or simple answer to the questionof how far IFSI is legally required or permitted
across the jurisdictions covered, or in any
single jurisdiction. The legal rules that apply todifferent investor types vary considerably between
jurisdictions. Their content, application andinterpretation reflect the culture of the jurisdiction
concerned. Even within a jurisdiction, there aredifferent rules for different categories of investor.
In addition, the circumstances of each investor
are unique. Because of these differences, precisely
what an investor is legally required or permitted
to do will also be specific to that investor: investors
need to consider their position on a case-by-casebasis (see Part B.2). Nonetheless it is still possible
to reach a set of broad conclusions about what thelaw generally requires or permits. The following is
not intended to be an exhaustive statement of all
the circumstances in which IFSI could be requiredor permitted (see Part B.3).
• Financial return as the primary goal ofinvestors
The primary purpose of Asset Owners’ investment
activity is generally regarded (by legislators,
regulators, courts and the Asset Owners
themselves) as generating a financial return for
beneficiaries within acceptable risk parameters.
Thus, applicable legal duties have generally
been interpreted to require financial investment
objectives to be prioritised, and in some casesa financial return is the only goal that an Asset
Owner should pursue. This is then reflected in
the terms upon which Asset Owners appoint
investment managers.
• Instrumental IFSI
If an Asset Owner or investment manager
concludes, or on the available evidence ought
to conclude, that one or more sustainability
factors poses a material risk to its ability toachieve its financial investment objectives, it will

generally have a legal obligation to consider what,
if anything, it can do to mitigate that risk (using
some or all of investment powers, stewardship,policy engagement or otherwise) and to act
accordingly. Possible options include seeking tobring about specific sustainability impact goals
that can reasonably be expected:• to help influence the relevant sustainability

factor(s) or the exposure of investee enterprises
to it/them; and• to do so in ways that reduce the investment risk.

Investors also talk of addressing sustainability
factors that present risks of this sort as being
necessary for long-term value enhancement.
It is also possible to envisage cases where an
investor seeks a return consistent with its
financial objectives by investing in and working
with a number of enterprises to tackle specificsustainability challenges in order to achieve an
increase in their value.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY
A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Relevant factors for an investor in determining
whether it should engage in instrumental IFSI
include the direct and indirect costs and risksof pursuing this course of action (including as
between different generations of beneficiaries,
where relevant), and the relative likelihoodthat doing so will help address the relevant
sustainability factor so as to reduce the financial
risk posed (or realise financial opportunities). An
investor may decide to act individually. However,both of these factors are likely to weigh in favourof a decision to foster or join collective investor
action aligned with the same goal.
In current conditions, it seems unlikelythat an investor, acting alone in publicmarkets and considered in isolation, would
have sufficient influence over an investee
enterprise’s sustainability impact to justify useof its investment powers alone as a basis for
instrumental IFSI. However, it is more foreseeable
that a group of investors, acting collectively andFreshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGEXECUTIVE SUMMARYCONTENTSFOREWORDSINTRODUCTION

holding in aggregate a substantial portion of
the securities of relevant investee enterprises,or proposing to invest at scale, could achieve an
impact of this sort, especially if their proposed
action aligns with similar market movements
more widely.
Especially in relation to publicly traded investee
enterprises, we anticipate that stewardshipand public policy engagement are likely to bea particular focus for investors considering
instrumental IFSI. However, where an investor has
concluded that it should engage in stewardshipto pursue sustainability impact, it may also
conclude that it should use or threaten to use its
investment powers from time to time to over orunderweight investee enterprises in the portfolio
or exit altogether, to strengthen its voice insupport of that. Doing so to achieve a positive
sustainability impact would fall within theconcept of instrumental IFSI.
• Ultimate ends IFSIThere will be a legal duty to IFSI where an
investor is managing the assets of an investment
arrangement that has specific sustainability impact
objectives, for example, a mutual fund establishedwith the aim of bringing about a particular type ofsustainability impact. This would involve ultimate
ends IFSI. These sorts of investment arrangement
are permissible in most relevant jurisdictions insome shape or form, subject to compliance with
consumer protection safeguards.
In most jurisdictions, certain other investors arealso likely to have legal discretion to engage inultimate ends IFSI, but usually only as a parallel
objective alongside financial return objectives.
Examples include: where some Asset Owners
have discretion to pursue sustainability objectives
provided adequate financial returns are achieved;
where beneficiaries have indicated that they wantthis; and in some cases where the Asset Owner isa corporate insurer. In the case of the last, whilesome of a life insurer’s investment activity may
15

be restricted by insurance policy terms, directorsof insurance companies will otherwise be guided
in their investment approach by the broader
interests of the company, which may permit the
pursuit of positive sustainability outcomes.
Most jurisdictions prohibit investors fromengaging in certain activities, such as money
laundering, and compliance with theserestrictions can be said to have a positive
sustainability outcome. An example more
specifically targeted at investors, but lesscommon, is legislation prohibiting investment
in businesses manufacturing cluster munitions,with the goal of causing manufacturing tocease. Clearly, it would not be usual to think ofcompliance with rules of this sort as IFSI. Thatsaid, the prohibition of support for activities notaligned with the SDGs has the equivalent impact
to a collective ultimate ends IFSI decision by
investors to achieve reduction in these activities.
In a few jurisdictions there are also positive
sustainability related legal obligations in relation
to the use of investment powers.
• IFSI and collective action
Collaboration with other investors is likely bothto reduce the costs and enhance the prospects ofa successful sustainability outcome and thereforeof achieving the goals of IFSI investors. This
may well weigh in favour of a decision to act,
whether the investor is discharging a duty toachieve financial returns or pursuing a discretionin the context of ultimate ends IFSI. Investor
cooperation at some level is clearly permitted inall jurisdictions (although there are legal rulesthat need to be complied with) and a significant
number of collaborative ventures are alreadyunderway at both national and international
levels, such as Climate Action 100+ and thosementioned in paragraph 6. Whether or not thereis the possibility of formalised collective action,
the activities of other investors or third parties
which are aligned with the investor’s goal could

also be relevant in deciding whether to act if, forexample, they increase the prospect of the goal
being achieved.
What investors’ duties may require withregard to collective action will depend on theircircumstances. Some large investors may be ina position to catalyse collective action. Where
collective action is already underway, smaller
investors may conclude that adding their weightis a cost-effective way to pursue their investment
goals. However, in understanding how any action
has helped an investor to discharge its duties, thefocus of a court would likely be on the logical andevidential credibility of the investor’s explanation
for the difference it has made in the context ofthe collective action as a whole more than the
precise quantification of the individual impact
or benefit of its involvement: the essence ofcollective action is that the sum is intended to begreater than its parts and for any one investor tobenefit from a sustainable system the system as awhole must be sustainable.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY
A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES• IFSI and delegation to investment managers
Asset Owners commonly delegate day-to-day
investment management of all or part of theirassets to investment managers. These tend to
conduct the bulk of stewardship activities and also
undertake policy engagement. In doing so, theyneed to balance or otherwise manage the various
objectives of their clients. Given the high levelsof AuM now concentrated in the hands of theworld’s largest investment managers, they are an
increasingly significant feature in the stewardshipand policy landscape. This concentration has
the potential to lower the unit cost of theirstewardship activities and increase their impact,
considerations which, as noted, would tend tofavour a decision to act.
Asset Owners delegating to investment managers
need to satisfy themselves that the activities of the
manager are aligned (or at least not inconsistent)with their own goals and duties to beneficiaries.
Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGEXECUTIVE SUMMARYCONTENTSFOREWORDSINTRODUCTION

However, subject to that, where an Asset Ownerconcludes that it is otherwise appropriate to appointa particular manager because that manager canmost fully support its needs, it seems unlikely that
the Asset Owner would be prevented from doing so
simply because the manager’s stewardship approachis not identical to what the Asset Owner would do if
it had its own in-house stewardship team.
• The significance of investor disclosure
regimes for IFSIThe legal and policy landscape relevant to IFSI ischanging rapidly. This includes rules requiring
institutional investors to disclose how far they
have taken sustainability factors into account intheir investment process. The fact that there isa disclosure regime of this sort will not usuallyon its own be sufficient to change an investor’s
underlying legal duties; it does not of itself
tackle the question of whether and in whatcircumstances IFSI or any other sort of sustainable
investment is required or permitted. However,where the law is unclear on the extent to which
an investor is permitted to take sustainability
factors into account, this kind of disclosure
regime could potentially be an affirmative factor,
for example, if it appears to be based on theassumption that they are permitted.
7.2 What rules say and the circumstances inwhich they are applied

As noted at paragraph 5 above, whether
legal rules require or permit IFSI in practicedepends both upon what the rules say and thecircumstances in which they are applied, andcurrent circumstances may limit what is possible
as a technical matter or in terms of cost.
However, circumstances can also influence
investors’ decisions by affecting what is thought
relevant to them. In this context, many market
professionals suggested to us in the course of
our project that certain market features (suchas commonly used investment theories and16benchmarks or the effect of intermediation andthe relatively short-term nature of investment
management agreements) may result insustainability factors receiving insufficientattention in the investment process (see Part B.4). If
this is correct, then it could undermine investors’attempts to comply with their duties, including
decisions on activities within the scope of IFSI.
Taking this a step further, in considering whether
an investor has complied with its legal duties, acourt or regulator may, among other things, assess
the investor’s actions by reference to establishedprofessional practice. Where an investor has
done what would be considered appropriate by arespected body of professional practice, then a claim
is generally less likely to succeed. Consequently,
if sustainability factors are being underweighted
in the course of existing market practice, thenlegal duties could unintentionally strengthen that
tendency because of how those duties interact, orare believed to interact, with market features.
Investors need to understand these potential
issues and ensure that they nonetheless comply
with their duties. Among other things, as
circumstances change, so should investors’decisions on what they are required or permitted
to do. For example, as awareness grows of thefinancial risks and opportunities created bysustainability factors and how investors can
respond to them, existing legal rules (notably,
those imposing standards of care and skill) will
likely lead investors to act in future in ways theywould not necessarily contemplate today.
8.

Facilitating IFSI through policy: what canbe done?

While there are circumstances in which thelaw requires or permits IFSI, there are also
impediments (see Part C.1). Policymakers may beable to help address them.
Where policymakers decide to intervene, they needto make their purpose clear since this will drivea host of subsequent decisions, not just on which

policy tools to use but also in the way investors
will apply any new rules. Subsequent judicial or
regulatory interpretation may also take the purposeof a given legal measure into account. The purposeof intervention will often be to secure financial or
economic goals, but it may also concern achieving
overarching sustainability outcomes consistent withinternational commitments.
Facilitating ultimate ends IFSI raises a particularquestion about how best to achieve outcomesaligned with core social values and the role ofinstitutional investors in that. The answer has
potential implications, financial and otherwise, forbeneficiaries, wider society and future generations. It
may be possible to place a monetary value on somesustainability outcomes in trying to balance theseneeds. Certainly, many have financial implications.
However, the value of positive sustainability
outcomes ultimately rests in the life that depends onthem and is not solely financial. These issues need
to be addressed by the relevant societies througha political process. It is not realistic to expect
institutional investors to resolve them on their own.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY
A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Since the behaviour legal rules produce depends
on what those rules say and the circumstancesin which they are applied, we identify options
for policymakers wishing to facilitate IFSI thattackle both (see Part C.2 and the Appendix tothis Executive Summary). They are possibilities
for consideration, not recommendations. They
are not exhaustive. They do not cover wider
interventions in primary economic activity or
fiscal policy (which can also fundamentally affectinvestment decisions), although policymakers willundoubtedly want to consider these.
Sustainability challenges are often systemic andinternational. International policy coordination istherefore likely to heighten the impact of policychange. Coordination may also be needed at anational level between regulators responsible fordifferent categories of institutional investor, toensure a consistent approach.
Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGEXECUTIVE SUMMARYCONTENTSFOREWORDSINTRODUCTION

APPENDIX — SUMMARY OF POLICY OPTIONS FOR FACILITATING IFSI
1.

Change investors’ legal duties anddiscretions and how they are understood

1.1

Investor duties and instrumental IFSIIntroduce guidance making clear that indischarging existing duties to seek to achieve afinancial return, pursuing sustainability impact
goals is an option that investors should consider(for example, in responding to systemic financial
risks created by sustainability factors).
1.2

Investor duties and discretions andultimate ends IFSIIntroduce or extend existing discretions to allow
investors to pursue sustainability goals thatreflect actual beneficiary preferences, assumed
beneficiary preferences (based on third-party,
potentially government, research), or objectives
set by government. The scope for this would
probably be greatest where any discretion is
subject to prioritising financial investment goals.
For especially pressing sustainability goals,
consider requiring investors to pursue them or
refrain from activities inconsistent with them.
This is a blunt tool, so may only be feasible, if atall, for very precise and urgent goals.
Particularly for insurers, guidance on or, if
necessary, legal reform to directors’ duties tosecure the success of their company, making clearthat success is not limited to narrow, short-term,
financial measures but should be understoodby reference to broader factors relevant to thecompany achieving its purpose over the long-term.
1.3Collective action to securesustainability goals

Investor cooperation to address sustainability
challenges is widespread. However, guidance
could make clear that investors should consider
collective action in seeking to achieve theirobjectives and that this can assist in discharging
17

their duties even if the investor’s contribution
and the portfolio benefit cannot be precisely
measured (since, like political security, thebenefits of sustainable systems as a whole areenjoyed by each person that relies on them). As
an alternative, this could be in the form of a prima
facie legal presumption in favour of cooperation
unless there are solid reasons against.
1.4

Rules that could inhibit
stewardship activity

Review competition law and rules on handling pricesensitive information, shareholder concertedness
and collective action in relation to a legal entity, andrules on requisitioning shareholder votes, to ensurethat they do not unnecessarily restrict stewardship
activity on sustainability factors. Where necessary,adjust to provide greater freedom or provide
guidance to reassure investors that freedom alreadyexists. In the case of competition law, consider
an explicit safe harbour for sustainability related
investor initiatives.
1.5‘Financial factors’ and ‘non-financial factors’

Review use of these expressions. Guidance should
turn not on whether a given factor is ‘financial’,
but on its implications for the objective of theinvestor; where an investor is discharging a duty
to pursue a financial return, and a sustainability
factor (or any other factor) is materially relevantto that, then the investor needs to decide what to
do about it. Use of these expressions should also
avoid giving the impression that sustainability
factors that only have indirect financial
implications (for example, because of reputationalrisk), or sustainability risks that are hard to
predict, are not relevant.

ACKNOWLEDGEMENTS

2.

Change the circumstances in which investors
discharge duties and exercise discretions

Strengthen IFSI ‘infrastructure’

2.1

Support for development of market-based
IFSI infrastructure

Steps to support the development of knowledge,
practice and market-wide consensus in areas
necessary for investors to engage in IFSI, making iteasier for them to do so; for example, the ability todefine sustainability impact goals and assess progress
towards them, and to understand the relationshipwith financial outcomes. This could include
facilitating specialist work and centres of excellence
in which solutions can be worked through, andhelping to establish the outcomes as authoritative.
2.2 Frameworks for IFSI capacity-building byinvestors

Establish frameworks for capacity-building byinvestors (in terms of their processes, systems
and controls for addressing sustainability impact)using ‘process regulation’ or industry goodpractice statements that set out practical steps
that investors could or should take in considering
whether to pursue sustainability impact goals
and how. The most stringent standards could beapplied to investment products and strategies
held out in ways that suggest they achievesustainability impact goals.

EXECUTIVE SUMMARY
A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

2.3 Corporate disclosure and reporting

Internationally consistent disclosure regimes
for businesses, generating ‘decision-useful’
information, are key for all forms of IFSI.
Policymakers need to consider, as they already are,how best to facilitate these and various associatedmatters such as any need for external validation.
Logically, investors seeking to address the effectof sustainability factors on their portfolio in theround could be expected to need two sorts ofFreshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGEXECUTIVE SUMMARYCONTENTSFOREWORDSINTRODUCTION

information: how an enterprise is impacted byand is responding to sustainability factors, andhow the activities of an enterprise have an impact
on sustainability factors (since the second of these
could be relevant to the sustainability position ofother portfolio companies). Disclosure regimes
could involve financial quantification of costs andopportunities, and publication of transition plans,in relation to key sustainability factors.
2.4 Ascertaining investors’ sustainability
attitudes generally

High-quality government-sponsored work toestablish greater clarity about the sustainability
attitudes of individual investors generally (socentralising cost and reducing uncertainty) for use
by institutional investors in exercising discretionin relation to ultimate ends IFSI (where permitted
based on investor wishes) and policy formation.
2.5 Strengthen stewardship code coverage ofmatters relevant to IFSI

Ensure that there is a stewardship code applicable
to all key business enterprises, investor-types
and investment relationships (so not justrestricted to publicly traded equity) covering,
among other things, enterprise risks (systemic orotherwise) from sustainability factors, possible
use of sustainability impact goals in seeking toenhance long-term value growth and collective
engagement towards that end.
Consider how adherence is strengthened (using,for example, industry working groups, publicationof stewardship policies and outcomes and external
review of stewardship standards).
Review the relationship between asset owners andinvestment managers (and advice given on this byconsultants) to ensure that the interests of asset
owners as they concern sustainability factors arebeing adequately reflected in stewardship activity
conducted by investment managers on their behalf.

18Address investment market influences thatmay diminish attention to sustainability
factors in the investment process

2.6 Portfolio theory, use of benchmarks andshort-term trading activity

Intensive high-quality cross-disciplinary
work coordinated by a group of investors andinternational-profile academic institutions on:• the use of key elements of portfolio theory andbenchmarks to establish whether they result ininsufficient attention to sustainability factors,
especially systemic risk, and whether this could
prejudice the realisation of financial goals; and• short-term trading activity to establish

whether it helps achieve, is inconsistent withor is neutral with regard to achieving positive
sustainability outcomes.
Further policy options would depend on the results
but, in the case of the first, could include continuing
education requirements and a review of businessschool training to ensure appropriate coverage.
2.7 Selection and appointment of investment
managers

Market studies on how far longer-term investment
approaches (factoring in sustainability risks andopportunities for clients beyond the term ofa manager’s appointment) are being properlyreflected and incentivised, including in relation to
stewardship, and what can be done if they are not.
Encourage the development of good practicestandards on diligence, appointment, monitoring
and relationship management, potentially
supported by disclosure requirements for asset
owners on how they approach these, including in
relation to sustainability factors that are relevantto their objectives.

2.8 Investment consultants and fiduciary
managers

ACKNOWLEDGEMENTS

Market studies on how far investment consultants
and fiduciary managers adequately establish
asset owners’ sustainability needs and goals andreflect these in their services, and whether theuse of portfolio theory and benchmarks in service
provision is appropriate. Any concerns could be
addressed by rules and guidance for asset owners
or directly through consultancy industry work on
good practice or regulation.

EXECUTIVE SUMMARYTransparency and market discipline as
to IFSI investment approaches throughhelping individual investors realisesustainability aspirations

2.9 Disclosure of sustainability approach,including on pursuing sustainability
impact goals

Institutional investor disclosure on how achieving
their objectives could be affected by sustainability
factors and their response, including whether thatinvolves pursuing sustainability goals, how andwith what success. Since a range of approaches
could fall within IFSI, consider ways of enabling
individual investors to understand the intensityand quality of the IFSI approach of the relevant
institutional investor.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

2.10 Sustainability impact-focused investment
products

Distinguish between labels such as ‘sustainable’,‘responsible’ and ‘impact’ and make their use
dependent on satisfying minimum operating anddisclosure standards including, in the case of impact,
the credible intentional pursuit of sustainability
impact goals and assessment of progress.

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGEXECUTIVE SUMMARYCONTENTSFOREWORDSINTRODUCTION

2.11 Encourage independent rating ofsustainability impact products

ACKNOWLEDGEMENTS

Steps to take greater account of investors’
sustainability aspirations in investment services
and distribution.

EXECUTIVE SUMMARY

Require investment managers, consultants andadvisers to establish a client’s sustainability
objectives at the outset of their relationship,including in relation to pursuing sustainability
impact goals, and reflect these in their service
provision. Alternatively, there could be a
regulatory presumption that each investor has
a long-term horizon and/or that they wish theirmoney to be managed in ways that achieve certain
sustainability goals.
2.12 Beneficiary education

Undertake investor education campaigns to help
them understand that their money can make adifference in sustainability terms, how (especiallythe role of pursuing sustainability impact goals),
and the possible trade-offs involved.

19

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPCONTENTS

A LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJURISDICTIONSFOREWORDSINTRODUCTION

CanadaUnited Kingdom France

Netherlands

EU

Japan

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

United States

20

BrazilSouth Africa

China

Australia

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTIONINTRODUCTION
Part A of this report looks at what is meant by‘investing for sustainability impact’ (IFSI) andwhere it fits in the current investment landscape.
It provides the context for the rest of the report.
• Section 1 describes the concept of IFSI. It also

outlines the relationship between IFSI and what
is often called ‘impact investment’, and with‘sustainable investment’ more widely.
• Section 2 looks at the need for three elements

when considering IFSI from the perspective oflegal rules: clarity about the impact goal being
pursued; the ability to assess how far a goal has
been achieved; and an understanding of thecausal link between an investor’s activity and agiven outcome. It touches briefly on emerging
frameworks for goal setting and assessment,
and the challenges of doing so.
• Section 3 gives a sense for what proportion of

global AuM could currently be described as
invested for sustainability impact.
• Finally, Section 4 surveys growing evidence

that investors are often motivated not just by adesire to earn a financial return, but also wantto support sustainability outcomes consistent
with the ideaof IFSI.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

21

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

1.

WHAT IS INVESTING FOR SUSTAINABILITY IMPACT?

1.1

Introduction

1

The key feature of IFSI is the sort of goals
an investor is pursing: the investor’s
investment purpose. An investor engaging
in IFSI will always be using its powers to
try to bring about assessable changes inbehaviour or circumstances that support
positive sustainability outcomes, including
the reduction of negative outcomes. In
this report, targeted changes of this sortare called ‘sustainability impact goals’.
An investor might pursue sustainability
impact goals by, among other things,
seeking to influence the activities ofbusiness enterprises or sectors or public
policy relevant to those enterprises.1

2

3• generating a financial return for the• the relationship between IFSI and what

investor or its beneficiaries; andis often called ‘impact investing’ (Section1.3); and• allocating capital to business enterprises

and others in need of funding.2
4

5

One purpose of pursuing sustainability
impact goals is likely to be protecting
or enhancing the financial performanceof the investor’s portfolio (including
supporting the sustainability of systems on
which financial value depends). However,an investor may regard the sustainability
outcomes it is pursuing as ends inthemselves. Clarity on this question of
purpose is important because of how
the purpose of an activity influences theway it is undertaken and its outcomes,
including decisions about what legal rules
are introduced and how to apply them. It
is also fundamental in terms of which legal
framework applies to the activity.
The idea of IFSI reflects the fact that, as afunctional matter, institutional investment
serves essentially two purposes:

ACKNOWLEDGEMENTS

6

Until relatively recently, the first hasreceived the most attention among
institutional investors and their advisers.
However, there is growing awareness of thepotential for investee enterprises positively
and negatively to affect the social andnatural environment on which, among
other things, they and the investment
returns they generate depend. The concept
of IFSI addresses this.
So, the idea of IFSI poses a question forinvestors similar to that raised for businessenterprises by the growing attention to‘corporate purpose’: what is the purposeof economic activity and how does it relate
to the wellbeing of people and planet?
Questions of investment purpose andcorporate purpose both concern what isvaluable: valuable not just financially,
however important that is, but also interms of outcomes for the social andnatural environments on which people
depend to survive and flourish. IFSI
approaches these questions from theperspective of investors; corporate purpose
from the perspective of the companies
in which they invest. In answering them
it is helpful to recognise that they areconverging on similar ground.
The following looks at three things:• what IFSI is (Section 1.2);• the relationship between IFSI andsustainable investing more broadly(Section 1.4).
1.2

Investing for sustainability impact
defined

7‘Investing for sustainability impact’ or‘IFSI’, is not a legally defined expression
and it is not used in this report as a termof legal art. Nor is it intended to add tothe alphabet soup of the sustainability
world. Instead, it serves here as no morethan a ‘conceptual net’ to catch, in broad
terms, any activities of an investor of a sort
described in the Introduction (paragraphs
1 and 2).

8

9

A key aim of our project has been to reacha view on the basic question of how far
the law requires or allows for investment
approaches that fall within that net, aspart of or in addition to the usual financial
goals of the investment process. We do notneed an exhaustive definition of IFSI to dothat. A grasp of the basic concept and its
constituent elements is enough.
As noted, IFSI involves seeking to achieveassessable impact goals. This aspect of
IFSI is discussed further in Part A. 2.
However, putting it to one side for thepresent, the core concept of IFSI involves
three elements: sustainability, sustainability
impact, and investing for sustainability impact.
The following discusses each briefly (seeSections 1.2.1-3 below), but it is important

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

22

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

to be clear from the start that an investor
engaging in IFSI is concerned with two
sorts of related impact:

for example, from a change in abusiness process to reduce the negative
sustainability outcomes produced by anenterprise (such as polluted water emission
levels), or the launch of a new enterprisethat generates positive sustainability
outcomes (such as developing battery
technology), through to higher-quality
enterprise sustainability disclosures
to inform investment decisions andimpact-orientated stewardship and policy
engagement. Goals of this sort might be
pursued on an enterprise-specific basis
or sector-wide. They could also involve
attempts to secure policy change that isrelevant to the operating environment for(a) businesses (ranging, for example, from
reporting regimes on what they are doing
to respond to sustainability risks to theiroperations, through to carbon pricing),or (b) investors (for example, to ensurethat their investment approaches onsustainability factors are transparent
and comparable for market users).

• first, the impact on social andenvironmental sustainability ofbusiness enterprises, and the impact ofpolicymakers and other third parties
on the operating environment forenterprises and investors; and• second, the influence, or impact, thatinvestors themselves can have on thesustainability impact of enterprises,
policymakers and other third parties.
1011

Some forms of sustainable investing focus
on the first, by investing in enterprisesthat are considered as having a positive
sustainability profile and avoiding thosethat are not (see Section 1.4 below).3
However, they do not necessarily involvethe investor intentionally seeking to
influence the sustainability impact of thoseenterprises. By contrast, IFSI is concernedwith both sorts of impact. It involves
an investor recognising that to achieve
its objectives it needs to set and pursue
sustainability impact goals.
Sustainability impact goals could
potentially take many forms, ranging,

12

In this report, the words ‘impact’ and‘outcome’ are used in accordance with
their ordinary English meaning, not inany specialist sense (see Box 1: Outcomes
and impacts).

ACKNOWLEDGEMENTS

Box 1: Outcomes and impacts
This report uses the words ‘outcomes’ and‘impacts’ extensively. There are various
disciplines, especially economics and sociology,
where, broadly, the term ‘impact’ when applied
to the activities of a particular actor implies
that they have changed something (ie beencausative) while the term ‘outcome’ is used todescribe a result in which the causative role of
the relevant actor has been less direct or does
not exist at all, or in a way that is neutral as towhat has caused it. However, in this report they
are being used in accordance with their ordinary
English meaning except where used in an
expression that has been specifically defined. In
other words, broadly:
impact is (i) the effective action of one thingor person upon another, (ii) the effect of suchaction, or (iii) used as a verb, the act of having apronounced effect on someone or something; and• an outcome is a state of affairs resulting fromsome process.4• The meaning of the two expressions therefore
overlaps. Because the word ‘impact’ has morethan one meaning we have, wherever used,sought to be clear about which sense applies.
In particular, when the report talks about an‘impact goal’, it means the desired effect of anaction or a desired outcome.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

23

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

1.2.1

Sustainability

13

The challenges of defining ‘sustainability’are well known.5 However, at its core, theconcept concerns the interconnected fateof people, planet, and prosperity.6 For the
purposes of this report, ‘sustainability’is treated as referring, as a minimum,
to an outcome that is consistent withthe social, environmental, economic andhuman rights goals suggested by a numberof international instruments, discussed
briefly below. In this report, we refer tothese goals as overarching sustainability
outcomes and the aspects of the naturalor social environment to which they
relate as sustainability factors (see Box
2: Sustainability factors). None of theseinternational instruments individuallyor collectively defines every aspect ofsustainability comprehensively, and they
are generally only legally binding on
investors and enterprises where equivalent
standards apply under national (or, whereapplicable, EU) law.7 They can, however,be relevant to the discharge of investors’
duties, among other things, for the reasons
discussed in this report.

Box 2: Sustainability factors
The expression ‘factor’ in the context of‘sustainability factors’ is used in the general
sense to denote a fact or circumstance thatcan contribute to a particular outcome. It is not
being used in the technical investment senseof ‘factor investing’ (ie broadly, an investment
approach that selects investments based onfeatures (or ‘factors’) that are believed to be
associated with higher returns, whether thosefeatures relate to individual investee enterprises
or are macroeconomic).

14

15

The seminal 1987 Brundtland Report
defined ‘sustainable development’ as,‘development that meets the needs of thepresent without compromising the abilityof future generations to meet their own
needs.’8 When people talk of ‘sustainable
development’ they do not necessarily meanquite the same as ‘sustainability’, and theBrundtland definition gives rise to somemuch debated questions, such as what sortof ‘needs’, how many ‘generations’, and soon. However, in practice, the formulation
has continued to underpin international
development and sustainability efforts inthe decades following.9 The 17 Sustainable
Development Goals (SDGs) and theiraccompanying framework of targets
and indicators are now the most widely
recognised international blueprint forpursuing a more sustainable world by2030 and cover all three elements ofenvironmental, social and economic
sustainability.10 The Paris Agreement under
the UN Framework Convention on Climate
Change reinforces the SDGs’ climatechange goals, establishing commitments
to seek to limit global warming within two
degrees Celsius of preindustrial levels.11
Sustainability is also often taken toencompass a wider set of international
norms concerning businesses’ managementof environmental and social impacts,
their adherence to human rights andlabour standards, and their approach to‘business ethics’. These are articulated in
instruments such as the OECD Guidelines
on Multinational Enterprises,12 the Ten
Principles of the UN Global Compact,13 andthe UN Guiding Principles on Business andHuman Rights.14

1.2.2

Sustainability impact

16

Sustainability impact concerns the effectthat human activity has on how far
overarching sustainability outcomes of thesort described above are being realised.
As used in the expression ‘investing forsustainability impact’, it is particularly
concerned with the sustainability impact
of business enterprise. In this report,
business enterprise includes any sort ofbusiness enterprise ranging from major
listed international corporations throughto private businesses and investment inpublic sector projects designed for private
investment. It also includes businesssectors. However, IFSI also concerns theactivities of policymakers as relevant to theoperating environment for businesses andinvestors, including their sustainability
impact and the sustainability risks towhich they are exposed and, in the caseof investors, their ability to exercise
an influence.

17

All business enterprises have sustainability
impacts, positive or negative. An enterprise
has a positive sustainability impact where
it does something that advances anoverarching sustainability outcome. Thiscan include steps to eliminate activities
that make those overarching outcomesless likely. The aim of IFSI is to influence
the activities of businesses so that theychange in a way that supports identified
overarching sustainability outcomes while
not causing a material deterioration in
the impact of the businesses on othersustainability outcomes, recognising that
there may be situations where a balanceneeds to be struck.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

24

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

18

Investee enterprises are also potentially
exposed to the negative sustainability
impact and reliant upon the positive
sustainability impact of third parties,
including other investee enterprises,businesses more broadly, and the activitiesof policymakers. Their financial return,and hence the investment return they
produce, and their ability to achieve theirshort and long-term goals depends, in part,on others. IFSI may also therefore involve
pursuing sustainability impact goals in
relation to these third parties.

1.2.3

Investing for sustainability impact

19

IFSI is not simply about investing inenterprises that are already well alignedwith achieving overarching sustainability
outcomes and divesting from those that are
not, although that could be part of an IFSI
strategy. Rather, the key defining featureof IFSI is an investor’s recognition that toachieve its objectives it needs to set andpursue assessable sustainability impact
goals. As noted previously, sustainability
impact goals can involve targeting
reduction in the negative sustainability
impact of a third party or an increase
in its positive sustainability impact. The
following looks at what sort of goals are
involved ((a)) and how investors might seek
to pursue them ((b)).

(a) The different sorts of goals involved in IFSI

20

21

Achieving the sort of overarchingsustainability outcomes described in
Section 1.2.1 in full is obviously beyond
the power of any single actor. The goals
targeted by investment activities within
the scope of IFSI would nonetheless either
be intended to contribute to achieving
those outcomes or at least have that effect.
Essentially, therefore, it is possible tothink of the goals involved in IFSI at threelevels, although investors may not always
approach them in quite this way:
• first, the investor would establish which

overarching sustainability outcomesare relevant to the investor in managing
its portfolio;22• second, the investor would articulate agoal (or goals) for its activities in relation
to its portfolio which, it is reasonable tothink, would be consistent with helping
to bring about that outcome at somelevel that is relevant to the investor indischarging its duties or exercising its
discretions (operating in a similar way toa financial investment objective, but inrelation to sustainability); and• third, the investor would identify aseries of more specific steps it can taketo secure action on the part of businessenterprises or other third parties which
it is reasonable to think will help torealise that goal.

23

Examples of the first would be achieving
the climate change targets set by the Paris
Agreement or ensuring availability andsustainable management of water andsanitation for all (SDG 6). An example ofthe second might be to ensure that allcompanies in an investor’s portfolio havecredible, regularly updated, transition
plans that are aligned with that outcome.
An example of the third would beenterprise-by-enterprise targets for steps
they need to take to achieve alignment
and the steps the investor will take toencourage them to do so.
This report treats both goals describedat the second bullet point above andthe specific steps described at the thirdbullet point as sustainability impact
goals. However, it will be clear that there
is a distinction between the two (whichbecomes relevant, for example, in thecontext of assessing an investor’s impact).
This difference is highlighted below whereparticularly pertinent.
We have identified two sorts ofsustainability impact goals, the pursuitof which would be consistent with IFSI.
The distinction between them is key inthe analysis that follows, so much so that
we distinguish between two sorts of IFSI
depending upon which goals are being
pursued: instrumental IFSI and ultimate
ends IFSI. See Box 3: Two sorts of IFSI:
instrumental IFSI and ultimate ends IFSI.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

25

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

Box 3: Two sorts of IFSI: instrumental IFSI
and ultimate ends IFSI
Two sorts of sustainability impact goals would beconsistent with IFSI:• where achieving the relevant sustainability
impact is ‘instrumental’ in realising the investor’s
financial return goals, for example, where an
investor concludes that its financial return
goals may not be realised unless a particularoverarching sustainability outcome can beachieved and the targeted sustainability impact
goal can help with that; and• where achieving the relevant sustainability
impact goal, and the associated overarchingsustainability outcome, is a distinct goal, pursued
alongside the investor’s financial return goals, but
not wholly as a means to achieving them.
This is a key distinction. We refer to pursuing goalsof the first sort as instrumental IFSI and pursuinggoals of the second sort as ultimate ends IFSI.15• Instrumental IFSI could include, among otherthings, seeking to protect or enhance portfolio
value by pursuing sustainability impact goals (a)that are intended to help in addressing systemicrisks (see Box 4); or (b) that address risks oropportunities created by a given sustainability
factor for a series of investee enterprises or asector which could have financial implications(and hence affect portfolio value), thereby
improving sustainability in the area concerned.
• The goals of ultimate ends IFSI can be broader.
While ultimate ends IFSI would involve seeking
to achieve a sustainability impact goal as an end

in itself (ie because of its positive contribution tosustainability), that does not necessarily meanthat the goal, if achieved, would not be alignedwith investors’ financial goals. Nor does it meanthat the sustainability impact goal concerned
must take priority over an investor’s duties tosecure a financial return, although that would
be possible. It simply means that a decision ispartly motivated by the desire to achieve thesustainability impact goal as an end in itself.
In practice, different elements of human motivation
cannot be neatly separated in this way so, in reality,
there may be a good deal of motivational overlap
between ultimate ends IFSI and instrumental IFSI.
In any event, factors that are often described as‘non-financial’ could conceivably turn out to have
longer-term financial implications (making theshorthand use of expressions like ‘financial’ and‘non-financial’ to distinguish between things thatcan be more or less easily measured in monetary
terms potentially misleading).
Connected with this distinction is the ongoingdebate in various jurisdictions over when ESG
factors are considered ‘financially material’ - and,as a result should be taken into account in theinvestment process (see Part B.2, Box 1) - and theextent to which ‘non-financially material’ or ‘nonfinancial’ factors can ever be taken into account.
The underlying assumption involved in focusing
on financial materiality is that the only goal ofinvesting is to achieve a financial return and thatESG factors should be taken into account whenmaterial to realising this goal. However, as noted bya number of those we have spoken to in preparing
this report, sometimes another set of concerns is

implicitly being debated between the lines of this
discussion. The language is that of financial return,reflecting the desire of those involved to comply
with their legal duties on generating financial
returns. Yet an underlying question concerns how
far portfolios should or can be managed in a waythat supports both longer-term financial goals
and positive sustainability outcomes.16 Sometimes,
these aspirations are more explicit.
The distinction between financial motives
and wider motives for investing is nonethelessimportant in following and enforcing legal rules.
That is mainly because not all sustainability factors
will necessarily be financially material to a portfolio,
even in the long-term. In general, as will become
clear later in this report, current legal rules are
more likely to require or permit IFSI where this
supports the realisation of an investor’s financial
goals (ie instrumental IFSI) than they are to requireor permit ultimate ends IFSI.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

26

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

Box 4: Systemic risk
In recent years investors have increasingly
focused on what must be done to protect thevalue of their portfolios from system-wide risks
created by the declining sustainability of various
aspects of the natural or social environment.
System-wide risks are the sort of risks thatcannot be mitigated simply by diversifying theinvestments in a portfolio. They threaten thefunctioning of the economic, financial and wider
systems on which investment performancerelies. If risks of this sort materialised, theywould therefore damage the performance of aportfolio as a whole and all portfolios exposedto those systems. In this report, we call thesesystemic risks, although in other contexts they
are sometimes described as ‘systematic’, ‘nondiversifiable’ or ‘market’ risks.17
Identifying all the sustainability factors thatcurrently present systemic risks for investors lies
outside the scope of this report. It is possible toimagine that, particularly in the longer-term,
there could be quite a number. However, themost obvious example at present is the riskof a climate change disaster, and pursuingsustainability impact goals that address it
so as to protect portfolio value would bewithin the scope of IFSI. In the words of the
Bank of England, ‘The financial risks fromclimate change have a number of distinctive
elements which present unique challenges
and require a strategic approach to financial
risk management.’18

24

The important topic of how investors’
sustainability impact goals are defined andset, and how progress towards them can beassessed, is discussed in Part 2. However,there is a separate question of whatpractical steps investors can take to seek toachieve sustainability impact goals. Whatis appropriate would depend, among otherthings, on the sort of sustainability goal
involved and asset class but three broadmeans of influence are available:• decisions on which enterprises to invest

in and, potentially, on what terms;• stewardship activity with investee

enterprises; and• seeking to shape public policy as it

concerns business enterprises and theiroperating environment and the ability ofinvestors to influence them.19
25

The first two concern how investors
seek to influence enterprises,20 the third
relates to investors’ relationship with
policymakers. The following looks briefly
at each. In practice, however, the useof these approaches is inter-connected:
legal duties that are most relevant to thequestion of whether an investor should or
can seek to achieve sustainability impact
goals concern an investor’s activities as awhole, not one sort of activity in isolation.
Most obviously, stewardship may be more
effective if combined with the prospect offurther capital allocation where progress ismade or divestment if it is not. Until now,
attention has tended to focus on the useof investment powers. Because of that, our

ACKNOWLEDGEMENTS

project has considered these three activities
separately to assess what investment duties
require or permit in each case.

(b) How investors can pursue their goals

EXECUTIVE SUMMARY(i) Powers of investment and divestment
The example of Zurich Insurance Group‘As a global insurance company with a growing
presence in emerging markets, Zurich is
exposed to many of the risks associated withclimate change, competition for scarce natural
resources and extreme poverty. We believe that
impact investments, which can have a targeted,positive and measurable effect on society and theenvironment, while generating a financial return
commensurate with the risks they entail, are one
way to help mitigate and address the exposure
to such risks: this is also why Zurich has directinterest in sustainable economic growth and indeveloping resilient communities.’
Manuel Lewin, Head of Responsible Investment, Zurich
Global Investment Management21

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2

26

Providing capital to, or withdrawing it
from, an enterprise has the potential toinfluence the sustainability impact of theenterprise by supporting or incentivisingsome activities over others. However, theeffectiveness of using investment powers
in this way will depend upon the asset type
and precise circumstances. For example,
it may be more effective in specificsituations, such as where a company isseeking to raise new funds or to ‘roll’ its
bonds (replacing maturing with newly
issued bonds) or early-stage investment(such as that provided by impact investors,
see Section 1.3 below) in private enterprises

Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

27

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

that may not be able to access mainstream
sources of capital. Further, especially inthe context of a collective action withother investors, decisions to overweightor underweight a company’s stock may
well influence its behaviour even where no
new capital is being raised (see discussionof collective action in Part B.2, Box 2).
Investment decisions (or the threat ofthem) can also be used to enhance theeffectiveness of stewardship activities,
especially where they are likely to provide
a respected signal to the wider market.22
27

28

29

30

However, reliance on investment powers
to achieve sustainability impacts also has
its limits.23
First, an important question concerns
how much influence investment decisions
have on a company’s activities where
the company is large and its securities
are listed and liquid.24 Once securities
have been issued and finance raised,
investors no longer hold the purse strings;
companies are not principally dependent
upon trading in the secondary market for
their funding (although executives whose
remuneration is partly dependent on stock
prices may have a different interest).

‘…in a world in which many investors trade
only based on securities’ financial performance,
it is difficult to argue that merely trading thesecurities of public companies, based on social orenvironmental criteria, will affect the quantity ofthe social value they produce.’25

31

That said, assessments of the importanceof ‘exit’ over ‘voice’, divestment overstewardship, can sometimes be overly
focused on its limited effect on share priceand underestimate the practical impact on (i)the behaviour of company management of
having the company’s stock put on investor
stop lists and (ii) investor and consumer
attitudes more widely because of what
it signals.26 That is partly why exit or the
threat of it can be a way of strengthening
voice in stewardship discussions.
Second, there is limited scope for passive
investors to use investment powers
strategically, unless the design of the index
they track results in the allocation ofcapital to enterprises in a way that achieves
positive sustainability impacts.27 However,passive investors may still have someflexibility where they are not seeking to
replicate the index perfectly (see Part B.2,
Box 4 and Part B.4, Box 6).
Third, investors may feel constrained inallowing sustainability considerations
to influence investment decisions
where investment practice is focusedon short-term financial performance.
While sustainability risks can crystallise
in unpredictable ways, the prospect isoften perceived to be longer-term, sothat sustainability risks may not be fullyreflected in shorter term investment
prices. Among other things, investors may
be concerned at the possibility of legal
liability if they invest by reference to what
are thought to be longer-term criteria
and funds underperform by reference toshorter-term measures (see Part B.4).

32

Finally, it may be difficult to verify thatinvestee enterprises have used capital in a
way that really changes their sustainability
impact. For example, there have beensuggestions that discretely financed‘sustainability projects’ using ‘green
bonds’ may sometimes effectively be used
to shelter the non-sustainable activities ofan enterprise by focusing external funding
decisions on ‘green’ activities.28 Wherethat is the case, it may be relevant to thequestion of whether investment is likely tosecure a sustainability impact.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?

(ii) Stewardship33

34

Depending on the jurisdiction, type ofenterprise and investment relationship,
there is a range of other ways for investors
to influence investee enterprise behaviour,such as introducing shareholder resolutions,voting at general meetings (including
supporting resolutions strategicallyintroduced by other more active investors,
thereby minimising their own expenses29),
monitoring and reporting on aspects ofbusiness activities, providing management
training and technical assistance, andengaging in dialogue with management.
This report refers to these activities
collectively as ‘stewardship’ althoughpeople also sometimes describe them as‘engagement’ or ‘active ownership’.
It is sometimes assumed that stewardshipprincipally concerns the use of formal
shareholder powers, such as voting rights.
However, dialogue with management may
be one of the most effective stewardshiptools, with the possibility of investor
resolutions and use of investment

Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

28

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

powers in the background.30 There areunderstandable concerns in some quarters
over the legitimacy of discussions of thissort which are inevitably not as public asshareholder meetings, especially where
investment is concentrated in a small
number of institutions.31 These concerns
are not the subject of the current exercise.
However, as a minimum, ensuring that
there is a wider social consensus on thegoals of stewardship activities should help
to allay them.

support for what can loosely be describedas modern portfolio theory, which might
inhibit the use of investment powers forsustainability impact, an investor may still
be able to engage in stewardship (subject
to considerations discussed more fully inPart B).
37

Stewardship compared with use of investment powers
35

36

Stewardship is likely to be a particularly
important IFSI tool, especially for thoseinvesting through public markets.32 In
contrast with the use of investment
powers, stewardship may provide greater
scope to influence the way in which capitalis allocated within an enterprise or otherareas of its behaviour.33 Investors may also
have greater freedom in practice to engage
in stewardship as compared with using
investment powers.34
First, some existing market features
may tend to focus investors on portfolio
composition (ie use of investment
powers) to secure shorter-term financial
performance. However, stewardship does
not directly affect portfolio composition.
Further, any impact from stewardshipon investment performance, short-termor otherwise, in relation to a given
enterprise is shared across all investors
and reflected in the benchmarks against
which investment performance ismeasured (see Part B.4). So, for example,
in jurisdictions where there is strong legal

designed to help it to meet its portfoliolevel sustainability impact goals) and toassess whether those targets have beenachieved than it is with decisions onwhether to invest in an enterprise or not.
Concentrating on stewardship may also
prevent instruments issued by enterprises
with poor sustainability performance
being passed on to investors who areless concerned about, and therefore lesslikely to engage those enterprises on,
sustainability impact, (although in someareas of sustainability, especially the movetowards net-zero, the number of investors
in that category appears to be reducing).37

Second, investors that have adopted
passive investment strategies, with little
or no flexibility over investment selection,
are still, in principle, able to engage in
stewardship.35 Large passive managers
increasingly recognise their responsibility
to do so.

‘In managing our index funds … BlackRockcannot express its disapproval by selling thecompany’s securities as long as that company
remains in the relevant index. As a result,
our responsibility to engage and vote is more
important than ever. In this sense, index
investors are the ultimate long-term investors –providing patient capital for companies to growand prosper.’36

Stewardship and investment managers
40

41
38

39

Finally, the legal terms governing
the investment of portfolios (such as
mutual fund investment policies andregulatory rules on portfolio liquidityand diversification) may constrain theuse of investment powers in pursuing
IFSI in a way that does not always affectstewardship activities to the same degree.
As a practical matter, particularly inpublic markets, it may also be easier to
identify specific sustainability targets for
an investor’s stewardship activity (ie steps

In practice, much stewardship activity isundertaken by investment managers onbehalf of their asset owner clients withvarying degrees of asset owner involvement.
However, managers’ incentives to engage
in stewardship have been mixed, withinvestment selection activities tending toovershadow stewardship.38
For active managers, trading a given stock
may often be a more efficient way ofrealising or protecting value than engaging
with an enterprise. For passive managers
or those with highly diversified portfolios,
diversification reduces the impact ofenterprise-specific performance factors on
portfolio performance, potentially reducing
incentives to engage, and results in holdings
in a large number of enterprises, potentiallylimiting the prospects for meaningful
engagement across the portfolio.39 However,there are ways of addressing this.40 Because
managers have shorter-term mandates

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

29

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

and will be assessed on their investment
performance, they could also have less of an
incentive to consider the sort of longer-term
implications of sustainability-related risks
which may lead asset owners to want toengage in stewardship activity. There arealso expense considerations. Consequently,
while stewardship capacity may be an
emerging source of competitive advantage
between firms, there may also be reluctanceto incur more cost than is necessary.
Asset owners who recognise a need forstewardship in pursuing sustainability
impact goals should address issues such asthese in the terms upon which they appoint
their investment managers.
Stewardship and collective action
42

30

It can be challenging for a single investor ina large enterprise, acting alone, to influence
the sustainability impact of that enterprise,or to do so cost-efficiently. However,fostering change through joint stewardship
activity is a different matter (see Part
B.2, Box 2).41 The concentration of asset
ownership at large institutional investors(sometimes called ‘universal investors’)potentially gives them particular influencein this context, including by catalysing
collective initiatives involving investors
with lower levels of AuM.42 The increasing
consolidation of investment managementin the hands of a small group of global
investment managers (see Part A.3.2.2)
may also strengthen shareholder voice
where those managers engage on behalfof their clients: in a sense consolidation ofmanagement can also bring consolidation ofvoice although even large firms recognise arole for collective action.43(iii) Public policy engagement

43

44

Investors can also engage with
policymakers, regulators and others inseeking to influence the direction ofpolicymaking on matters relevant toachieving sustainability impact goals.44
In practice, however, the extent towhich some categories of investor will
feel able to do so may be influenced bycultural expectations or even more formal
regulatory guidance in the jurisdiction
concerned (see further in Part B.3).
Policy engagement can include, among
other things, addressing issues that inhibit
investors from investing for sustainability
impact (eg uncertainties over investor
duties), addressing legal or practical barriers
faced by business sectors in moving tomore sustainable business models, andencouraging interventions in primaryeconomic activity or fiscal policy (forexample, policies designed to achieve atransition to a ‘green economy’) which
can help to reduce systemic risks but also
fundamentally affect investment decisions.
In other words, policy engagement could
be focused on the behaviour of investee
and potential investee enterprises, factors
relevant to an investor’s ability to influencethat behaviour (such as the need for
effective, consistent and internationallystandardised disclosure on sustainability
factors), or other areas of activity that create
risks or set the operating environment for
those enterprises or investors. The goalsof engagement can be inter-related. For
example, some investors have suggested
that they are currently hampered in using
their investment powers to invest inenterprises that are aligned with averting

climate change due to a shortage of suitablepotential investees, adopting a ‘best in class’approach instead. Changes in industrial
policy designed to tackle climate change
might be expected to stimulate new
businesses or changes in existing businesses
that would generate opportunities.
45

Engagement may be especially significant
for long-term investors who may be morereliant on policies that ensure market
integrity, resolve market failures andaddress damaging government action.45
However, sustainability-related risks toa portfolio could also crystallise in the
short-term. Investors unable to manage
these risks effectively at enterprise or
portfolio level can seek solutions throughpolicy engagement. As with stewardship,
it is in principle possible to undertake
engagement regardless of what has driven
portfolio composition.

1.3

Investing for sustainability impact and‘impact investing’46

An obvious question concerns therelationship between what is commonlyreferred to as ‘impact investing’ and thekind of activities that fall within thescope of IFSI. Essentially, the concept
of IFSI is broad enough to cover impact
investing. Indeed, there appears to be astrong correlation between the two at a
broad conceptual level. However, they are
distinguishable, in particular, because of thesort of investors and investments involved.

47

Interest in various forms of ‘impact
investing’ has grown in the last decade.
Various international initiatives haveemerged that seek to define what it is anddevelop effective approaches for managing

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

and measuring impact outcomes. They
have led the way in generating valuableknow-how and investment tools. They
include the Global Impact Investing
Network,46 the Impact Management
Project,47 the Operating Principles for
Impact Management48 (promulgated by
the International Finance Corporation),the ‘Future of Investing’ platform of theWorld Economic Forum,49 the OECD Social
Impact Investment Initiative,50 the Global
Social Impact Investment Steering Group51
and the (wider in scope) United Nations
Environment Programme Finance Initiative
Positive Impact Initiative.52 There is joint
working between many of these groups.
48

As noted, there is a basic consistency
between the features of IFSI and the key
elements of impact investing, as describedby the groups and initiatives mentioned
above.53 With differences of emphasis, theway they define impact investing involves
three recurring themes:• the key distinguishing feature is its

purpose, which is to secure identified
positive outcomes of some sort;54• there is generally an expectation that theinvestor’s purpose also includes earninga financial return; and55• the importance of being able to assess

progress in achieving the relevant
impact goal.
49

The main area of difference concerns
the way impact investing functions inpractice, especially (i) the types of investors
involved and (ii) the sort of enterprises
in which they invest and the associatedmethodologies applied. This may result,in part, from its origins at the interface
between investment and philanthropy(see Part A, Appendix 1). Some of theinitiatives mentioned above seek to draw
on and apply more widely experience andtechniques developed in this context.

enterprises that may not be able to accessother capital sources. Impact investing
has historically been less concerned withsecuring sustainability impacts in larger,
more mature and diversified businesses,
including major multinationals whose
securities are traded on the world’s
investment exchanges. However, as noted,that has begun to change. The concept
of IFSI is intended to catch impact-driven
investment activities whatever sort ofbusiness enterprise is involved.58

Investor types
50

In terms of investor types, impact
investing has tended to be the preserve ofdevelopment finance institutions, private
investors and specialist investment funds
more than major institutional investors
and investment firms. That has begun
to change in recent years with attempts
to ‘mainstream’ impact but, at leastin the context of capital allocation, it
remains largely the case. Even wheremore ‘mainstream’ investors use theirinvestment powers to engage in impact
investing, they can tend to do so throughspecialist impact investing units more thantheir core investment activity.56

1.4

The relationship between investing forsustainability impact and ‘sustainable
investment’ more widely

52

IFSI falls within a group of investment
approaches in which social, environmental
and economic sustainability factors aredeliberately taken into account in someway. These include ‘ESG investing’,‘impact investing’, ‘ethical investment’,‘socially responsible investment’,‘sustainable investment’, ‘stewardship’and ‘responsible investment’.

Investment targets
51

As to what these investors invest in,while it is not easy to generalise, thetargets have often been discrete, earlystage, private enterprises that tend to
be concerned with addressing a specificsocial or environmental issue; enterprisesthat have sometimes been described as‘impact-driven organisations’.57 They fallalong a spectrum from those intended
to generate market levels of investment
return through to others which prioritisea social or environmental goal. Some
impact investors think of ‘impact’ interms of the positive impact their capitalprovision can have for these early-stage

53

The main difference between investment
approaches that are within the conceptual
net of IFSI, and sustainable investment
approaches that are not, concerns
investment goals. All approaches tosustainable investing involve investors
pursuing investment goals. However, thedefining characteristic of those within thescope of IFSI is that an investor recognises
that, in order to achieve its goals, there
is a separate need to set and pursue
specific sustainability impact goals andassess progress towards them – it involves
the investor intentionally seeking to

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

31

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

influence the sustainability impact of thoseenterprises in assessable ways.
54

enterprises carry less investment risk).
By contrast, instrumental IFSI involves
deliberately setting and pursuing specificsustainability impact goals for one ormore business enterprises; realisingthese goals is regarded as necessary
to achieve a desired outcome beyond
the sustainability impact goal itself,
namely financial return or reduction of
investment risk.

Broadly, the main approaches tosustainable investing tend to involve somecombination of the following:• making investments or excluding themfrom a portfolio based on an explicit andsystematic inclusion of environmental,social and governance factors ininvestment analysis to better manage
risks and improve returns (generally inthe short-to-medium term);

to ultimate ends IFSI. However, again
there is a difference. That is not because
the motivating values are necessarily
different, but because it tends to involve
pursuing those values by avoiding
investment in companies that are notvalue-aligned and, possibly, the hopethat diverting capital away from themwill stimulate change (as to which, see
Section 1.2.3(b) above). By contrast,
ultimate ends IFSI involves setting
and pursuing specific sustainability
impact goals for one or more businessenterprises in order to align market
practice with those values.

investments to rule companies in or outof contention for investment based on an
investor’s preferences, values or ethics;• various forms of stewardship activity;• various forms of sustainability-themed

investing, where there is anintention to contribute to specificenvironmental or social outcomes,
including impact investing.59
Both the first and second of these could
certainly be used as part of an IFSI
strategy.60 However, considered as distinct
activities, neither necessarily involves
pursuing sustainability impact goals,
unlike IFSI which does.
• The first might look like instrumental

IFSI in that it is concerned withachieving a financial goal. However,it tends to involve allocating capital
based on the quality of an enterprise’ssustainability standards on theassumption that this will yield better
investment returns (for example,
in the belief that more sustainable

57• Likewise, the second might seem similar• applying filters to lists of potential

55

of investors towards, for example, steel
companies with a good understandingof how to decarbonise their business,
intended to persuade other companies inthe sector to develop effective transition
plans would potentially do so.

56

So, for example, merely reshaping aportfolio so that it is less exposed tofinancial risks posed by sustainability
factors (eg by screening to remove
entities with a poor understanding of
how to decarbonise their activities)
would not of itself fall within IFSI since
it does not involve setting and seeking
to achieve specific sustainability impact
goals (although, as noted, that does notmean it could not be used as part of an
IFSI strategy). However, a deliberate andwell-signalled move by large numbers

58

59

We are not intending to suggest thatthe reshaping of investment portfolios
with the intention of reducing financial
exposure to a risk posed by sustainability
factors should only happen where theinvestor is also pursuing a particularsustainability impact goal. We stress thedistinction merely because this reportis primarily concerned with activities
designed to achieve sustainability impact
goals, whether to improve to the quality offinancial return or as an end in itself.
Similarly, if an asset owner were to invest
in an enterprise that had a purpose thatinvolved making a positive sustainability
impact, but chose that investment only
because it anticipated an attractive
financial return, this would not be
IFSI, even though the enterprise might
generate a positive sustainability impact.
That is because the asset owner’s only
goal is financial return, not achieving asustainability impact. Once again, we are
not suggesting that such a decision would
be any more or less legally permissible
than one intended to achieve a positive
sustainability impact. We are justdelineating the activities with which thisreport is primarily concerned.
Both of the forms of sustainable investing
described in the first two bullets ofparagraph 54, above, could nonetheless

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

32

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

have sustainability impacts that may bealigned with IFSI (see Part B.2 Box 3).61 For
example, as noted above, inclusion of acompany on investors’ stop lists because of
the company’s poor sustainability record
would likely attract directors’ attention.
60

61

62

33

As to the third form of sustainable/
responsible investing, stewardship
activity, it follows that when stewardshipis designed to result in improvementsin the sustainability footprint of a given
enterprise or sector, it may often be aform of IFSI. That is because it necessarily
involves assessing the current activity ofbusiness enterprises and seeking to change
it by reference to some sort of goal.
The fourth form of sustainable/responsible
investing includes impact investing (see
1.2 above). In some cases, investment
approaches in this category may therefore
fall within the concept of IFSI.
The terminology that is used to describe
different sorts of sustainable investing
has evolved over many years. For a briefsummary of the historical background, seePart A, Appendix 1. Common expressions,such as ‘sustainable investing’, aregenerally not legally defined, althoughlegislators and regulators do sometimes
use them, especially in guidance, and they
are beginning to appear in legislation.62
They also get used interchangeably orin ways that can make it hard to knowwhat they involve in practice and how
they differ. That suggests that there is
only a loose consensus about what theymean, which can be a source of confusionand criticism.63 As an indication of this,Part A, Appendix 2 provides a selectionof definitions advanced by well-known
institutions and industry bodies of someof the most commonly used expressions.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

2.

IFSI: GOAL CERTAINTY, ASSESSMENT OF IMPACT AND UNDERSTANDING AN INVESTOR’SCONTRIBUTION

2.1

Introduction

63

Section 1 looked at the basic concept of
IFSI. However, it deferred three key issues
to this Section 2:

do. That is because what legal powers,
duties and discretions require or permit
does not just depend on their ‘black
letter’ (ie what they ‘say’) but also thecircumstances in which they are applied(see Part B.2.2 and B.4).

• the need for an investor to be able toidentify sufficiently clear impact goals(ie goal certainty);

67• how progress towards the goals is to beassessed; and• how to understand what difference aninvestor’s action can make or has madein progressing the goals (ie the questionof causation or the investor’s contribution).
64

65

Each is needed for an investment approach
to be a form of IFSI. They also have abearing on what the legal rules consideredin Part B of this report require or permit
and on the policy options in Part C.
In what follows:• Section 2.2 looks at the legal significance

2.2

Requirements for legal rules relevant
to IFSI

68

Reasonable certainty about the goals being
pursued, an ability to assess progress
towards achieving them and an investor’srole in that progress are all important informulating and applying legal rules thatare relevant to IFSI.

of each issue; and• in light of that, Section 2.3 makes somehigh-level observations on the current
means available for addressing them.
66

Investors’ capacity to define impact
goals, assess progress towards them andunderstand their own contribution isdeveloping but is more advanced in someareas and in relation to some aspects ofsustainability than others. This presents
challenges for investors, not least in termsof expense.64 These challenges have abearing on what investors can and should

The challenges should reduce as market
frameworks and practice develop. However,for now they may lead investors to focus
on areas where the ground is more certain,
extending their activities as the ‘market
infrastructure’ evolves. Collaboration
between investors is one way to facilitate
solutions. Work can be undertaken
strategically, know-how shared, and costs
spread (see Part B.2, Box 2). Policymakers
may also have a role (see Part C.2).

69

By ‘legal rules’, we mean any legal
provision (whether established inlegislation or arising under judge-madelaw) that is intended to guide behaviour
by imposing duties or discretions orconferring powers.65 Most of the legal rules
considered in the legal assessments in theannexes to this report are in that category.

70

Legal rules are intended to influence
behaviour. Their effectiveness in doing that
depends, among other things, on:• clarity about the behavioural outcome

at which the rule is directed (ie goal
certainty);• a reliable way of working out whether it

has happened (‘assessment’); and• an expectation that the person at whom

the rule is directed has some influenceon the outcome, making it necessary
to be able to understand the relevant
person’s role or ‘contribution’ inbringing about a particular outcome.
71

None of these must be perfectly satisfied
to create new laws or apply existing ones.
However, some level of certainty is neededon each.

2.2.1

Goal certainty

72

Part A (Section 1.2.3(a)) identified three
types of goals that are relevant to theconcept of IFSI:• overarching sustainability outcomes

reflected in international instruments
such as the SDGs and the Paris
Agreement that are relevant to theinvestor in discharging its duties;• portfolio-level sustainability impact

goals an investor sets for its activities
which are consistent with helping tobring about overarching sustainability
outcomes that are relevant to theinvestor (similar to a financial

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

34

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

investment objective, but relating tosustainability); and2.2.2 Assessment75• the more specific steps an investor

can take to secure action on the partof business enterprises or other third
parties which it is reasonable to think
will help to realise the portfolio-levelsustainability impact goals (which could
be seen as a sustainability equivalent of
an investment policy).
73

74

An investor needs to be reasonably clear
about the portfolio-level sustainability
impact goal it is seeking, and the specificsustainability impact targets in its action
plan for pursuing that goal. It should also
have a reasonable basis for thinking that
achieving the portfolio-level sustainability
impact goal is aligned with moving towards
an overarching sustainability outcome thatis relevant to the investor.
In practice, investors’ portfolio-levelsustainability impact goals may not involve
specific outcomes that are either achievedor not but may instead be about securing
steady change of some sort that is alignedwith a particular overarching sustainability
outcome, such as ensuring that all
participants in a given business sector
have credible transition plans to net zero
emissions. They could also include steps todiscourage activities of a sort that are notso aligned. Whatever the goal, clarity is
still needed on what amounts to progressin achieving it. That might, in turn, be
defined, for example, by reference towhether the more specific impact targets
in an investor’s action plan are being met.

goals are therefore likely to involve some
sort of qualitative or numerical target,
the achievement of which is capable ofassessment by the investor and others.
Assessments would cover both progress
towards portfolio-level sustainability
impact goals and the more specific targets
set by the investor in pursuing those goals.
The outcome could also be consideredby reference to assessments of how far
overarching sustainability outcomes arebeing achieved.

Investors carrying on activities within thescope of IFSI may need to make or accessvarious assessments in seeking to discharge
their duties, including as to:(a) the extent to which humanbehaviour is aligned with overarchingsustainability outcomes and how thatis changing;(b) the impact of business sectors on (a)and how it is changing;(c) the impact of individual businessenterprises on (a) and (b) and how it ischanging; and(d) the impact of government policy on (a)to (c).

76

77

Assessment is needed before any steps aretaken, to define what action is needed,and during and afterwards to establish
whether it has been effective in achieving
the relevant goal. Assessments need to be
sufficiently standardised for those with aninterest, including courts and regulators,
to know that they are talking about thesame thing and to facilitate comparison
between outcomes achieved in similar
circumstances.
For an investor to define its sustainability
impact goals in the first place, it needsa credible basis for assessing how far
circumstances it is able to influence arealigned with overarching sustainability
outcomes that are relevant to it. However,once set, sustainability impact goals
remain largely meaningless without areliable way of establishing whether they
have been achieved. Sustainability impact

78

However, these are not the only kindsof assessment that investors seeking toachieve sustainability impact goals mayneed to undertake. Importantly, they will
also usually need to assess the effect, if any,of pursuing sustainability impact goals on
the financial performance of their portfolio(see Box 5).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

35

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

Box 5Assessing the impact of IFSI on financial
performance
Investors seeking to achieve sustainability impact
goals will generally need to assess how, if at all,doing so affects the financial performance of theirportfolio (see Part B.2 and 3). Potential challenges
include (a) a lack of clarity as to the nature andextent of exposures to sustainability factors at
individual enterprise, sectoral and system-widelevels and, consequently, their longer-term
financial and therefore portfolio implicationsand (b) the available measurement tools (seeSection 2.3.2 and Part B.4). Particularly when asustainability impact goal is intended to help in
addressing systemic risks, which are difficult toquantify, simple cost-benefit analysis is unlikely to
be feasible or appropriate. However, that does notmean that the risks are not real or that investor
activity cannot help in mitigating them. Decisions
may therefore need to rely, at least in part, on anassessment of the potential adverse impact for
portfolio value and performance if these risks are
not addressed.
The sort of judgements that may be neededon possible trade-offs between financial returnand sustainability impact could vary depending
upon whether the investor’s approach involves
instrumental IFSI or ultimate ends IFSI. In the caseof the former, the judgement is more likely to focus
principally on the timing and extent of any financial
impacts. However, since the value of sustainability
impact goals may not reduce to financial measuresalone, further challenging judgements may beneeded, particularly in the case of ultimate ends
IFSI. Since financial and sustainability assessment
methodologies are often not interoperable, there
is also potential for a ‘siloed’ approach between
staff focused on pursuing narrower financial
objectives and those concerned with sustainability
impact.66 Developing the necessary methodologies
is a matter of investment and wider practice. It istherefore not considered further here. However, it
is likely to be important in applying at least somelegal rules, especially rules that require investors
to prioritise financial return but nonethelessallow them to pursue what we have described as
ultimate ends IFSI.

79

The wider question of whether there is generally
an impact on portfolio performance where
investors deliberately take account of sustainability
factors and, if so, of what sort, has generated
considerable debate and provides some context
for these assessments but has not generally looked
at IFSI investment approaches.
Work to date has tended to focus on historicalperformance where investment selection in pursuitof financial investment objectives is influenced
by the ESG profile of investee enterprises.67 It isless concerned with, among other things, thepotential future performance impact of systemicrisk resulting from sustainability factors (except,
perhaps, to the extent these risks have alreadybeen reflected in that historical investment
performance). In view of the definitional questions
concerning sustainable/responsible investing
discussed in Part A.1.4, it is possible that some ofthis work included portfolios being managed inways that involved IFSI. Even so, it seems unlikelythat these portfolios would have comprised amaterial portion of the relevant assets undermanagement. Because of that and the definitional
ambiguities involved in concepts such as ESG,
that work may therefore be of limited relevancein making the sort of assessments mentioned
above. However, one of the most comprehensive
assessments of studies on this topic to date foundthat roughly 90 per cent of those studies indicate
at least a non-negative impact of taking accountof ESG factors and the majority suggest a positive
impact.68 Meanwhile, the IMF has concluded thatthe available literature on this point is inconclusive,
but that the performance of sustainable andconventional funds may at least be comparable.69

Given the definitional questions
surrounding sustainable/responsible
investing, some of the work mentioned
above may also have covered theperformance impact of sustainabilityrelated stewardship activity. However,while the understanding behindstewardship codes is that stewardshipis relevant to corporate value and hence
portfolio value, analysis of the financial
value implications of stewardshipspecifically concerning sustainability
factors remains a developing area.70 Thereis, nonetheless, some evidence that it canmake a positive difference, both in termsof investee financial performance,71 andin helping to protect shareholders fromthe risk of loss as a result of sustainability
factors.72 Less attention has been given to
the impact on financial performance ofpolicy engagement.

2.2.3 Understanding the investor’s
contribution
80

Investors need to use their legal powers toachieve the purpose for which the powers
were given. In deciding what steps to take,whether to pursue sustainability impact
goals or otherwise, they therefore need tobe satisfied that their intended actions will
help in realising that purpose, and in a waythat merits any proposed use of resources.
Similar considerations apply when they (andothers, such as courts and regulators) review
the effectiveness of what they have done.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

36

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

81

82

For each sort of sustainability impact goal
an investor sets, the investor and thosewith an interest therefore need to be able tounderstand the investor’s role in bringing
about a given change – ie there needs to bea credible basis for understanding the causal
connection between the investor’s actions andthe relevant outcome.

need to assess the investor’s contribution
may be limited. However, in practice,establishing an understanding of theinvestor’s contribution may focus especiallyon the investor’s influence, individuallyor collectively, on individual businessenterprises, sectors and policymakers.
83

Precisely what this might mean in practicewill differ depending on the investor’s
circumstances and strategy and the goalconcerned. The level of expense for theinvestor and its portfolio may also be
relevant; if a given step effectively involves
no expense or risk to the portfolio, then the

Perhaps most notably, as discussed in Part
A.1.2.3 there are differences between theinfluence an investor might have as asignificant source of capital for a private
enterprise as compared with investment
in public markets. In private (and in somecases in illiquid public) markets, investors
may have more control over the amountand cost of capital available to investee
enterprises and the terms on which it isprovided, allowing them to have more of
an influence on investees in addressing
their sustainability impact. This is lessfeasible as a secondary market investor in acompany with a large shareholder base. Inthat context, understanding the investor’s
contribution to a given sustainability
impact is likely to involve a greater focus
on outcomes achieved collectively withother investors (see Box 6 and Part B.2,
Box 2).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?

Box 6: Investor contribution and collective action
It is obvious to business people that achieving
just about any major commercial goal requires
collective effort. Large commercial projects areinvariably collective endeavours and even thecontribution of those directly involved depends
on the activities of third parties far beyond them.
Much as with an orchestra performing a piece ofmusic, a sports team in a competition, or evenvoting in an election, this collective activity isdesigned to bring about a desired outcome. It
produces a result for which each member is partly
responsible and to which each has contributed,
even if their role can only be fully understoodin terms of the collective whole and cannot
be perfectly separated out and defined. The
collective result is different from the product ofindividualised behaviours and can be significant
both to those directly involved and those affectedby their collective activities.

result of that action. However, it may not be able
to demonstrate that, viewed in isolation, the result
led to a particular sustainability outcome being
achieved or even advanced, that the sustainability
outcome concerned has enabled the investor toachieve its legal objectives, or that the collective
action would not have been successful but for its
own participation.

Similarly, an investor engaging in collective action
in pursuit of a sustainability impact goal which
is designed to help in achieving an overarchingsustainability outcome may be able to point to the

In the event of a dispute, courts may tend tolook more closely at whether a proper process
was followed than the outcome achieved indetermining whether duties have been discharged.

That does not mean that the investor has notmade a contribution and been discharging its
duties. However, in understanding what and how,
the focus would be on the logical and evidential
credibility of the investor’s explanation for thedifference it has made in the context of thecollective action as a whole, and other related
activity, more than the precise quantification of theindividual impact of its involvement: the essence ofcollective action is that the sum is intended to begreater than its parts.

Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

37

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

2.3

Observations on the current state ofmarket practice84

Investment frameworks, methodologies
and metrics are developing in each of thethree areas discussed above. Particularly
for sustainability goals such as tacklingclimate change, it is credible to thinkthat investors can make an effective
contribution, for example, by pursuingsustainability impact goals, and there aremany examples of this in practice (see Box7).73 In any event, we have assumed that in
preparing this report.

‘We cannot manage what we cannot measure.
The benchmark gives us the tool needed forengagement and to inform our proxy voting. The
first assessments show the scale of ambition,
where we are and where we need to get to, withmeasures along the way. We’re in the foothills ofa long climb. This is tough, but necessary.’
Anne Simpson, managing investment director,
board governance and sustainability,
CalPERS and Climate Action 100+ steeringcommittee member75

85
Box 7: The example of Climate Action 100+
Having seen a substantial increase in company
decarbonisation commitments, the Climate
Action 100+ initiative is increasing its focus
on actions and outcomes. It has recently
released a net zero company ‘benchmark’ forevaluating company performance in relation to
reducing greenhouse gas emissions, improving
governance, and strengthening climate-related
disclosures and assessing the extent to which
companies are delivering on their commitments.
‘… tangible outcomes at companies … must
happen for the initiative to succeed. … So far,
Climate Action 100+ engagement teams
have secured numerous net zero and SBT
commitments across a range of hard-todecarbonise companies and sectors where thiswas unimaginable a short time ago. … in less than
three years, the initiative [has] become the leading
driver of corporate decarbonisation efforts.’
Andrew Gray, director, ESG and stewardshipat AustralianSuper and Climate Action 100+steering committee member and chair,interviewed by Climate Action 100+.74

86

Nonetheless, the available tools andinformation are far from complete. There
has clearly been considerable progressin the area of climate change, and theexperience of the TCFD shows just how
swiftly this can happen.76 However, looking
at sustainability goals more broadly, there
is currently no commonly agreed basis,among other things, for investors to set
sustainability impact goals, for defining
what it is to have a positive sustainability
impact, for determining the sustainability
impact of an enterprise in the round, orfor measuring progress towards manypotential impact goals. There is also a lackof consensus as to which sustainability
factors present financial risks for investors,
or over what timescale, and uncertainties
that are challenging to resolve, for example
in terms of the second- and third-ordereffects of not achieving overarchingsustainability outcomes.77 Up to a point,
therefore, these questions need to beconsidered by investors on a case-by-casebasis, although investor coalitions can help
to beat a path for all.

87

88

We should emphasise that we are notsuggesting these issues mean that investors
cannot or should not seek to achievesustainability impacts. Part B considers
what legal rules require of investors or
permit them to do in terms of seeking toachieve sustainability impacts. Here, weare simply highlighting the likely need forfurther work for it to become more feasiblefor investors to pursue some sorts ofsustainability impact. This may influence
where investors are currently best able toconcentrate their efforts, and how.
Developing solutions is a work of many
hands. Our project has not been intended
to assess what is required. However, since
this market environment is relevant to
how legal rules apply, some of the moresignificant initiatives are mentioned briefly
below to indicate the kind of challenges
that investors may face. This provides acontext for the discussion of legal rules inPart B. Legal frameworks can also help in
addressing some of the challenges. This
context is also therefore relevant to thepolicy options in Part C.
The three themes of goal certainty,
assessment and understanding theinvestor’s contribution have been separated
out in what follows, but initiatives
mentioned under one heading aresometimes relevant to others. For example,
it may be challenging to define an impact
goal without reference to an assessable
numerical or qualitative outcome. In somecases, therefore, an initiative is mentioned
in one context rather than another simply
for descriptive convenience.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

38

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

2.3.1

Goal certainty

89

As discussed in Part A.1.2.1, internationalsustainability-related instruments suchas the SDGs and the Paris Agreement
can provide a high-level framework for
impact goal definition.78 However, thesewere principally intended for use bypolicymakers in setting country-level goals.
A certain amount of legwork is needed
to convert them into impact goals forinvestees and investors.

90

91

Ongoing initiatives should help to define
which business activities are alignedwith some of these overarching goals.
A prime example is the EU sustainablefinance taxonomy.79 This seeks to provide
a single basis for investors, issuers andpolicy makers to assess the environmental
sustainability of economic activities
referenced to six objectives: climate change
adaptation; climate change mitigation;
sustainable use and protection of waterand marine resources; transition to acircular economy; pollution prevention
and control; and protection and restorationof biodiversity and ecosystems. While itdoes not itself stipulate stainability goals,
it is based on national and international
goals and can be used in defining
portfolio-level sustainability impact goals.
The UK government intends to createa UK taxonomy and a number of otherjurisdictions are working on similar
frameworks including China, Malaysia,
New Zealand, Russia and South Africa.80
Yet investors still need to make judgements
in setting their sustainability impact goals.
These include the basic decision about

which overarching sustainability outcomesare relevant to their investment-related
activities and, in the light of that, which
portfolio-level sustainability impact goals
to adopt. This second step may involve
challenging decisions, for example, as towhether nuclear energy has a positive
sustainability impact by reducing fossil
fuel reliance, what is needed to ensurethat reducing fossil fuel reliance does notadversely affect social sustainability byfalling disproportionately on the mosteconomically vulnerable, and how toapproach the environmental impactsof technologies replacing the internal
combustion engine.
92

for signatories to have transitioned
their portfolios to net zero emissions by
2050 in line with the Paris Agreement.
Each provides a framework of steps forinvestors, including setting impact goals
which they pursue in the way they manage
their portfolios and undertake policy
engagement. For example, signatories to
the Target Setting Protocol commit to set
sub-portfolio-level targets for emissions
levels for investees represented by asset
classes within portfolios (starting withthose where there are already credible
methodologies and data and extending
as these develop for other asset classes).
These are combined, among other things,
with targets for investors’ stewardship andpolicy engagement and positive financing
targets to support net zero transitioncompatible business. The Climate Action
100+ aviation strategy provides an exampleof how this could work at a sectoral level.82

Various frameworks have been developedthat can help with setting portfolio-levelgoals. Very broadly, they approach the issue
from one of two overlapping perspectives:• determining which areas ofsustainability impact to target and thetype of impact the investor intends tohave; and• defining the quality of impact theinvestor is seeking.
93

The following looks briefly at examples ofavailable frameworks in relation to each.

(a) Target-setting frameworks

94

Two of the most fully developed examplesof target-setting frameworks are the Net
Zero Asset Owner Alliance 2025 Target
Setting Protocol and the Institutional
Investors Group on Climate Change Net
Zero Investment Framework, concerning
target setting in relation emissions
reduction.81 The basic aim of both is95

A further example of a target-setting
framework, this time by reference to theSDGs, is the PRI’s Impact Investing Market
Map. The stated aim is to ‘bring more clarity
to the process of identifying mainstream
impact investing companies and thematicinvestments so that asset owners and fundmanagers can better assess opportunities
in this market.’ The Market Map identifies
10 sustainable investment ‘themes’: energy
efficiency; green buildings; renewableenergy; sustainable agriculture; sustainable
forestry; water; housing; education; health;and inclusive finance. These themes
are linked to specific SDGs and theirassociated targets and indicators. The map
also includes a list of key performance

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

39

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

indicators that can be used by those seeking
to achieve sustainability impact goals toassess performance against a specific theme,
highlighting the close connection between
goal definition and assessment.83

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT(b) What quality of impact?

96

One of the most notable examples of aframework concerned with defining thequality of impact sought in a given area ofsustainability is the Impact Management
Project’s (‘IMP’) ‘five dimensions ofimpact’. These are part of the IMP’s ‘impact
norms’.84 The five dimensions of impact
identified by the IMP essentially help in
defining what it is to have an impact andhave been represented in tabular form, as
set out below (see fig. 1). However, they
are also relevant in assessing the extent
to which an impact has taken place andwhat steps are needed to secure it, again
highlighting the connection between goalsetting and other parts of the process of
pursuing sustainability impact goals.

ACKNOWLEDGEMENTS

Figure 1: The Impact Management Project five dimensions of impact85

INTRODUCTION

2.3.2 Assessing impact
97

98

To facilitate investment approaches
within the scope of IFSI, there is a need forreliable, consistent data on, and consensus
about, how to assess the sustainability
impacts of business sectors, enterprises andother third parties such as policymakers.86
As an example of the sort of assessment
challenges potentially facing investors, thefollowing focuses specifically on assessing
investee enterprise impact. There may
be similar issues with some of the otherassessments that an investor may need toundertake. That said, assessment may be
simpler in other contexts, for example,
where a specific policy change canreasonably be expected to result in marketwide behaviour aligning with an investor’ssustainability goals.

1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

40

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION99

In looking at enterprise impact, aninvestor may find it needs to assess, among
other things:• the impact of an enterprise on

overarching sustainability outcomes; and• whether that impact has changed overa given period in a way that can help
to realise an investor’s portfolio-levelsustainability impact goals.
100

In assessing enterprise impact, a key
distinction concerns:• frameworks for assessing enterprise

impacts;• disclosure and reporting frameworks

through which information relevant tothose assessments is made available by
the enterprise; and• metrics and other criteria that can beused in assessing enterprise impact.
101

The following looks briefly at each, but it isimportant to note that assessment involves
a number of interconnected challenges,
only some of which can be addressed bydisclosure and more effective metrics.
Focusing on disclosure might suggest thatthe necessary information is available
but not being adequately disclosed or,even if it is not currently available, can begenerated. However, some sustainabilityrelated risks do not lend themselves toeasy quantification and the long-term
consequences of some of them are noteasily foreseeable.

(a) Frameworks for assessing enterprise impact

102

Three basic frameworks have been
identified which can be used to assess

enterprise and portfolio-level impact. There
are no industry-wide standards for how
they should be applied, creating challengesof reliability and comparability in terms of
the resulting assessments.87

103• Impact targets: the investor selects anindicator or indicators that are relevantto the impact goal of the portfolio orfor specific portfolio investments anduses that to set targets for investee
enterprises at the outset of theinvestment relationship. The progressof the enterprise towards the target isperiodically reviewed thereafter. An
example of this would be setting a net
zero target for an investee enterprise.88• Impact rating: this is a more holistic

approach, so can be more complex andcostly. Essentially, it uses an overarching
impact rating system to capture multiple
sustainability impacts of an enterprise(or multiple impacts in a given area ofsustainability) and generate a single
overall numeric or qualitative enterpriserating.89 The investor therefore needs todecide which areas of impact to assess
and performance indicators to use forassessing positive or negative impact(eg by reference to the dimensions ofimpact, mentioned above). Weights
are then assigned to each factor indeveloping an overall rating.
• Impact monetisation: this attempts to

reduce desired environmental and social
impacts to monetary values, putting afinancial figure on progress towards agiven impact. Of the three approaches,

ACKNOWLEDGEMENTS

it is possibly the most demanding toapply effectively.90

104

Using these frameworks can involve
considerable judgement. Each has
advantages and disadvantages and can beapplied with varying degrees of depth andrigour. There may be benefits in using two
or more concurrently, or in relation todifferent parts of the investment process.
This is particularly so where an investor
wants to address an identified impact
theme (such as health) without causing adeterioration in the wider sustainability
impact of a given enterprise, ie there canbe a specific impact target assessment inrelation to the theme and a broader impact
assessment framework can be used toassess the wider sustainability impact of
the enterprise as a whole.
For all these frameworks there is no single
system for categorising and rating different
sorts of impact or determining appropriate
benchmarks. However, the UNEP FI’s
Corporate Impact Analysis Tool, launchedin 2020, seeks to help financial institutions
and investors to analyse the impacts ofclients and investee companies acrossdifferent sectors and countries. Its threestep approach involves identifying impacts
based on company typology, geography
and sector and assessing and monitoringa company’s impact performance andmanagement capabilities.91 Meanwhile, theSDG Action Manager seeks to provide a way
for companies to set impact targets andmeasure progress against them, sharing
data with relevant stakeholders as theychoose, including investors.92

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

41

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION(b) Disclosure and reporting frameworks forsustainability impact information

and reporting. A sub-set of these IMPmembers has been progressing efforts
towards a comprehensive corporate
reporting system.97 More recently,
September 2020 saw notable policy
communications from three initiatives tobring greater standardisation to corporate
sustainability disclosure and reporting:
the world’s leading sustainability
disclosure standard setters, CDP, CDSB,GRI, IIRC and SASB announced a sharedvision for comprehensive corporate
sustainability reporting and the intent
to work together to achieve it;98 theTrustees of the International Financial
Reporting Standards Foundation launched
a consultation to assess whether it should
establish a Sustainability Standards Board
as a standard-setter, complementing thework of these other bodies with the aimof greater standardisation (and have sinceconfirmed that work is underway toestablish a new International Sustainability
Standards Board);99 and there has been
work by the World Economic Forum withthe ‘big four’ accountancy firms designed
to identify a set of ‘universal, material ESG
metrics and recommended disclosuresthat could be reflected in the mainstream
annual reports of companies on aconsistent basis across industry sectors andcountries’ on sustainable value creation.100

International standard setters
105

There is a multiplicity of disclosure andreporting frameworks for enterprisespecific sustainability performance
information. The current arrangements
are fragmented and complex and, even
where enterprises use them to discloseand report, may not provide investors withdecision-useful information, for example
where disclosure requirements focus on
the activities of an enterprise in relation
to particular areas of sustainability, morethan changes in its sustainability impact.
The fact that each framework has beendeveloped for a different purpose adds
to the complexity. Notably, for example,
two of the most prominent sustainability
reporting bodies have different objectives:
SASB intends its reporting standards
to enable businesses to communicate‘financially material’ sustainability
information,93 whereas the GRI describes
its approach as an accountability
mechanism to ensure companies adhere
to responsible sustainability principles.94

106

However, there is now a clear recognition
that this complexity needs tackling.95 The
situation has been developing rapidly andinvestors are pressing for further progress.96

107

Since 2018 the IMP has facilitatedthe IMP Structured Network, a groupof international organisations thatare coordinating efforts to provide
comprehensive standards and guidance
for impact measurement, management108

For the present, however, the complexityand fragmentation remain and it is yet to
be seen how far these initiatives will resultin the sort of information that investors
need, or how soon.

ACKNOWLEDGEMENTS

TCFD and other international frameworks
109

On climate change, specifically, there has
been a rapidly growing alignment aroundthe disclosure standards published by
the TCFD (see Box 8). Work is currently
underway on additional guidance on theuse and disclosure of forward-looking
metrics.101 Meanwhile, within the investor
community itself, the Sustainable
Development Investments Asset Owner
Platform is intended to facilitate investor
assessment of companies based on theircontribution to the SDGs.102

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

42

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

Statutory regimes

Box 8
The Task Force on Climate-related Financial
Disclosures

110

The TCFD was established by the Financial
Stability Board in 2015. Following consultation,
it issued a set of recommendations on climaterelated financial disclosure. These are designed
to provide greater transparency to markets on
the climate risks companies are facing and tohelp companies understand what financial
markets want from disclosure in order tomeasure and respond to climate change risks,encouraging firms to align their practices anddisclosures with investors’ needs. The TCFD has
developed guidance aimed at organisations inall sectors as well as supplemental guidance forfinancial institutions and companies operatingin the energy, transportation, materials andbuildings and agriculture, food and forest
products sectors.
103

The TCFD recommendations are highly
influential and are being taken on board
by companies and in government policy ina number of jurisdictions where they areintegrated into governance and disclosure
requirements.104 The initial focus of the Better
Alignment Project between the CDP, GRI, SASB,
the CDSB and the IIRC has been on ensuringthat their standards are aligned with therecommendations published by the TCFD.105

Statutory corporate disclosure regimes
on so-called ‘non-financial’ reporting
have also been evolving, perhaps
most notably in the EU and UK. For
example, the EU Non-financial Reporting
Directive requires companies to disclose
information on, among other things,
environmental and social matters to
the extent the information is needed tounderstand the company’s performanceand impact.106 Essentially, this reflectsa ‘double materiality’ approach wherein-scope companies need to assess themateriality of these environmental andsocial factors to their own financial
performance, but also their own impact
on, essentially, environmental and social
outcomes (involving a distinction similar
to that made in Part 1.A, Box 3 between
instrumental IFSI and ultimate ends
IFSI).107 Important questions remainover how far disclosure and reporting
requirements should be set by regulation,and the extent of reliance on private
initiatives of the sort mentioned above.
Jurisdictional cultures vary, with somefavouring a more rules-based approachthan others.

Third-party data and ratings providers
111

Many large investors use third-party data
providers to support measurement ofinvestment impact. Those organisations
provide ESG data and scores and areincreasingly providing impact data thatcan be used, for example, in setting goals
and assessing progress. There is a separate
question about how information is usedby analysts and ratings firms in providing
resources for investors, for example, as tothe quality of extensively used sustainability
ratings produced by some agencies.108(c) Metrics and other available criteria forassessing enterprise impact

112

Similar issues surround the underlying
assessment metrics and standards onwhich disclosure is based.109 Very broadly,
it is possible to distinguish between:• separate standards that have beendeveloped to provide an indication of anenterprise’s sustainability performancein particular areas; and• reporting frameworks that may

incorporate some of those standards(with or without adjustment) and add
some of their own and which, in somecases, purport to provide an overview ofan enterprise’s sustainability footprint.
113

An example of the former is the 200 setsof industry-focused metrics and standards
which the SASB references in producing its
own 77 sustainability accounting standards(which are themselves an example ofthe latter).110 Other examples include
more than 200 sets of assessment tools
covered by the EU’s GLOBAL VALUE toolnavigator, designed to assist users to select

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

43

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

the most appropriate for their needs.111
Similarly, the PRI’s Impact Investing
Market Map organises commonly used key
performance indicators by sustainability
theme (water, housing, education etc.),112
the GIIN maintains the Impact Reportingand Investment Standards (‘IRIS’) Catalog
of Metrics113 covering over 600 impact
measurement tools and created specificallywith the impact investing community inmind, and the World Economic Forum
Measuring Stakeholder Capitalism White
Paper groups sets of metrics by reference
to four pillars (governance, people, planet
and prosperity).114
114

Looking specifically at impact assessment
practice among impact investors, according
to the GIIN 2020 survey of impact investors,of those surveyed, 89 per cent use external
resources to assess impact, the most common
being the SDGs (37 per cent), the IRIS Catalog
of Metrics (36 per cent), IRIS+ Core Metrics
Sets115 (29 per cent) and the IMP’s fivedimensions of impact (21 per cent).116

2.3.3

Understanding an investor’s
contribution - credibility and causation

115

Investors have developed various
approaches to understanding or assessing
the difference their activities makein changing the impact of businessenterprises and other third parties such aspolicymakers. This section looks briefly atsome of them.

116

Investors talk of these assessments interms of, among other things, having ‘animpact thesis’ or ‘a theory of change’,‘contribution’, and ‘additionality’ or ‘social
value added’.117 These concepts are not

identical but overlap. However, whatever
the context, the focus is on establishinga reasonable level of confidence thatsteps the investor is planning, or hastaken, are likely to lead in some way toa change of third-party behaviour that ismaterial in moving towards the investor’ssustainability impact goal.
117

118

As noted in Section 2.1, demonstrating
the precise extent to which an investor’sintervention has resulted in a change ofoutcome is not always straightforward.
Much may turn on the sort of activities
the investor is engaging in and withwhom, and what sustainability impacts it
is targeting. In some cases, the means ofinfluence necessarily involve reasonably
clear measures of an investor’s influence,either individually or as part of a group, forexample, where a company agrees to change
its practices following engagement with theinvestor community or where resolutions
are passed or legislation is changed.
In relative terms, understanding thedifference an investor has made is,perhaps, most straightforward where
an influential investor has a substantial
funding role in a privately held enterprisepursuing a goal which is aligned withrealising positive sustainability impacts.
Here, it should be possible to apply aform of ‘but for’ test, which is essentiallywhat the concept of ‘additionality’ does(see further below). Even so, outcomesare rarely the result of a single causal
factor and understanding the extent of
the investor’s contribution may therefore
still be challenging.118 In public markets,
where the bulk of institutional investment

is focused, there is likely to be more ofa need to look at the level of collective
sustainability impact initiatives in which
the relevant investor is involved (see Box 6
above).119
Impact thesis/theory of change
119

The idea of an impact thesis or theoryof change has been advanced as a wayof thinking about the whole process
through which an investor seeks to achievea change of impact, with a particularfocus on informing the planning andimplementation stage. Essentially, it is aformalised attempt to articulate (a) thesustainability impact that an investor isseeking to achieve and (b) how its activities
are likely to contribute to the change thatis needed to realise it.120 The first part ofthis concerns impact goals and assessment,
as to which see above. However, the second
concerns the causal difference the investor
will make in realising the goals.

Contribution
120

This expression is sometimes used todescribe what is, essentially, the second
part of an impact thesis and sometimes
outside that context. However, it tends
to be used as a generic way of describing
an attempt to explain the difference theinvestor’s involvement has made. The
concept is closely connected with the tools,
such as stewardship, that are available toinvestors to influence enterprises and third
parties,121 but goes beyond the questionof which tools are deployed to ask thequestion, ‘to what effect?’ ‘Contribution’has been described as, ‘a credible narrative,or thesis, which describes how … theACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

44

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

actions of the … investor will help achieve
the [impact] goal’ or how ‘… the outcome
would not have occurred…’ without theinvestor’s involvement.122
121

122

This reference to a ‘credible’ narrativereflects the point made above: it will rarely
be possible to attribute the occurrenceof a particular sustainability outcome toa single activity or measure the precise
difference that the activities of a single
investor have made to that outcome.
Because of that, the emphasis may often
need to be on the basis for and qualityof the investor’s explanation for thedifference it has made. For example, agiven change may have involved collective
investor action, or a combination of thatwith changing practice among otherenterprises in the relevant sector andpublic policy intervention or the threat ofit. Nonetheless, a credible narrative would
involve developing an evidentially solidand reasonable basis for understanding
how what the investor does – investment,
stewardship, policy engagement orotherwise – makes a positive differencecompared with the sustainability impactthat would have occurred without theinvestor’s intervention. Among otherthings, it may involve assessing the depthof the change that occurred and its
likely duration.123
Assessing an investor’s contribution isalso, therefore, likely to require someattempt to develop a view on what would
have happened without it. In some cases,
this may be relatively straight-forward,
using common sense, in others morechallenging. However, again, any viewneeds to be based on solid reasons. Whatmight be needed will depend very muchon the circumstances. In some cases,
it could include use of existing or evennew scientific or professional studies (forexample, based on comparison groups andrandomised control trials) and market or
stakeholder research, although even thesehave their limits.124
Additionality
123

124

Particularly within the impact investing
community, investors often use theconcept of ‘additionality’ or ‘social value
added’, especially in thinking about achange resulting from an allocation ofcapital or the provision of non-financial
inputs by an investor to a given enterprise
which would not otherwise have
happened. This concept is used to describe
different sorts of assessment. However, its
use in an investment context has emerged
from the work of development financeinstitutions, where it principally concerns
the role of an institution in influencing
the amount of capital being made available
to a given enterprise.125 In the context of
impact investing more broadly, it tends toinvolve assessing how far the investor’s
involvement adds to (rather than replacing)the existing ‘inputs’ to an investee
enterprise resulting in greater aggregate
positive sustainability ‘outputs’ than would
otherwise have been the case.126
Again, outcomes are assessed against
the situation that would have prevailed
without the relevant intervention (a‘counterfactual’) to establish whether
there has been an increase in the quantity

or quality of the positive sustainability
outputs of a given enterprise. However, thisapproach to the question of contribution
may be more valuable in some contexts
than others, especially non-public
investment situations.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

45

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

3.

WHAT PORTION OF GLOBAL AUM IS CURRENTLY SUBJECT TO INVESTMENT APPROACHESINVOLVING IFSI?

3.1

Introduction

125

The concept of IFSI has not so far
been used to define research on AuM.
Unsurprisingly, therefore, there is no easyanswer to this question.

126

There are estimates of the level of AuM
subject to sustainable investing in its
various forms. However, sustainable
investing is a fluid concept and is not thesame as IFSI (see Part A.1.4).

127

128

Further, as indicated in Part A.1 and
2, an investor could engage in IFSI
in various ways. Properly answering
the question would therefore require
qualitative assessment: the fact that assets
appear to be subject to an investment
approach within the scope of IFSI does
not necessarily reveal much about the
rigour of that approach or its outcomes.
For example, an investor could use its
investment powers, stewardship and public
policy engagement or only one of these; it
could do so intensively or not; and it could
focus on only one area of sustainability or
several. There is also the distinction drawn
in Part A.1 between instrumental IFSI and
ultimate ends IFSI, and the methodologicaland infrastructure challenges touched
on in Part A.2 which require judgementon the part of each investor and may be
addressed with varying degrees of rigour.
The bulk of global AuM do not currently
appear to be managed in ways that fallwithin the scope of IFSI. Nonetheless,subject to the important caveats justmentioned, the proportion of global AuM
currently managed in ways that could
involve IFSI appears potentially significant
and growing. This is based especially on theactivities of investor coalitions, and those
focused on climate change in particular,
whose activities appear to involve them,at least to some extent, in pursuingsustainability impact goals. Members of the
Net Zero Asset Managers Initiative and Net
Zero Asset Owners Alliance control AuM of$43tn and $5.7tn respectively.
129

130

The increasing concentration of AuM
in the hands of a small number of large
investment management firms potentiallygives them a particularly important role inthe development of investment approaches
within the scope of IFSI, subject to theterms of their mandates. For the growing
portion of these assets that are passively
managed, stewardship and public policy
engagement are likely to be the mostimportant means of doing so.
The following considers:• the size and distribution of theinstitutional investment market byreference to AuM (Section 3.2);• what portion of those assets are

believed to be managed by reference to‘sustainability’ factors (Section 3.3); and• what portion of those it might bepossible to regard as being subject toinvestment approaches within the scopeof IFSI (Section 3.4).

131

The figures used are largely taken fromassessments by established third parties
and we have not sought to verify them.
They are included here solely to provide arough indication.

3.2

Global AuM

3.2.1

Total AuM

132

Estimates of global AuM vary and values
have been in flux as a result of the
COVID-19 pandemic. However, one study
covering assets managed by investment
managers in 44 markets in 2019 found that
their AuM stood at $88.7tn.127 Meanwhile,the total AuM of 500 of the world’s largest
asset managers was estimated to have been
$104.4tn at the end of 2019.128

133

Since these are the figures for assets
managed by investment managers, theabsolute figure for global AuM (ie all assets
managed by asset owners or managers
on their behalf) is likely to be higher. For
example, the aggregate AuM managed
by PRI signatories (which include asset
owners), adjusted to avoid double counting,was estimated to have been $103.4tn as
at 31 March 2020.129 Since not all asset
owners and managers are PRI signatories,
the figure for global AuM is likely to behigher still. PwC have put the figure at$110tn.130 In a wider context, the World
Federation of Exchanges estimated thatthe global capitalisation of cash equity
markets was $109.21tn as at the end of
2020,131 and the Bank of International

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

46

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

Settlements estimated in its September
2020 quarterly review that the global
total of outstanding debt securities wasapproximately $120tn.132 Not all of theseassets are held by institutional investors.
At the same time, these are not the only
asset classes held in institutional investor
portfolios. Estimates of the aggregate
global AuM of each the three categories
asset owner covered by this report are as
follows: pension funds $52.5tn as at theend of 2020,133 mutual funds $ 63 tn as at
the end of 2020134 and insurers $ 35.4 tn asat the end of 2019.135 However, since bothpension funds and insurers hold interests
in mutual funds, and pension funds may
enter into life contracts with insurers, thesame assets may be represented more thanonce in these figures.
3.2.2 Who manages these assets?
134

135

The asset management sector is comprisedof many firms. However, there has
been substantial consolidation so thatmanagement of global AuM is increasingly
concentrated in the hands of a smaller
number of very large providers.136 The 10
largest investment managers as at the endof 2019 were estimated to be managing inexcess of $32tn or approaching a third of
the global AuM figures above, while the 20
largest accounted for approximately 43 percent ($44.9tn).137
BlackRock has for some time been theworld’s largest asset manager (AuM of$8.15tn) and Vanguard is the second largest(AuM of $7.1tn). State Street is the next
largest with $3.4tn.138 The three together
therefore manage over $18.5tn of assets.139

A substantial portion of those assets are
passively managed. Indeed, it is thoughtthat these companies manage about 80
per cent of all passively managed assets
and that some 22 per cent in aggregate of
the shares in the typical S&P 500 company
are held in passive or active portfolios
managed by them.140 They and a numberof other large firms therefore occupy an
influential position generally and in relation
to any move within the investment market
towards investing for sustainability impact.
3.2.3

What portion of global AuM ispassively managed?

136

The portion of global AuM that is passively
managed has been growing. It has been
estimated that the share of global AuM
managed by investment managers using
passive investment strategies stood at 21
per cent ($18tn) by 2019.141 This seems
broadly consistent with other estimates.142
For example, the AuM in index tracking
mutual funds is estimated to have stood
at $11.4tn by the end of November 2019,
while work by BlackRock in 2017 suggested
that the AuM in passive strategies outside
mutual funds could amount to $6.8tn,
producing a similar aggregate figure.143
It was estimated that in 2017 that 22.4
per cent of the AuM of 500 of the world’s
largest investment managers was being
passively managed, and the figure was
growing.144 In the US, where the movetowards passive investing is particularly
pronounced, by the end of 2018, actively
managed funds had an overall market
share of 61.2 per cent compared with 38.8
per cent for passive funds, with the trend
towards passive continuing in 2019.145

ACKNOWLEDGEMENTS

3.2.4 Geographic spread137

It has been estimated that, in 2019, North
American managers had the highest shareof global AuM ($42tn) and experienced
the strongest growth.146 Europe, thesecond largest asset management region,
also experienced strong AuM growth in2019, to $22.8tn.147 Some $6.1tn of thatwas managed in the UK.148 AuM in France
grew to $3.5tn.149 In Japan and Australia,
AuM grew to $6.6tn. In Asia (including
China and Hong Kong but excluding Japanand Australia) AuM grew to $11.2tn.
Meanwhile, AuM in Latin America grew to$1.9tn.150 Another study has highlighted
the growth in the AuM of North American
investment managers relative to otherjurisdictions between 2007 and 2017 from41.59 per cent of global AuM to 53.22 per
cent.151 The same study estimated that
North American clients also accounted for59.3 per cent of global AuM, underscoring
the point.152 This concentration of assets
and management firms in North America
suggests that the legal frameworks within
which North American asset owners
and managers operate are likely to beparticularly significant terms of the extent
to which global AuM is subject to IFSI.
That said, not all of these assets would
necessarily be managed from locations inNorth America.

3.3

Sustainable investment AuM

138

Sustainable investment is now a majorpresence in investment markets. As noted
in Part A.1.4, the concept covers a variety
of investment approaches. Some, if not all,could be used in the course of investing

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

47

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

for sustainability impact. However, they
do not necessarily involve IFSI. While there
is no data on the portion of global AuM
being invested for sustainability impact
specifically, assessments of AuM that aremanaged in ways that take some accountof sustainability factors ought at least to
catch those that fall within the scope of
IFSI as part of the total figure.
3.3.1

Total AuM managed by reference tosustainability factors

139

Since the concept of sustainable
investment covers a broad range ofactivities, taking account of sustainability
factors with varying degrees of intensity,
figures for global sustainable AuM need tobe approached with care. However, muchquoted research by the Global Sustainable
Investment Alliance (GSIA) suggests thatat the beginning of 2018 AuM of $30.7tn
was subject to some sort of sustainable
investment in the investment markets of
US, Europe, Japan,153 Canada and Australia/
New Zealand.154 This represented an overall
increase of 34 per cent in two years.

140

The growth has continued in the three
years since then. For example, it has been
estimated that the total of ‘sustainable
investing assets’ in the US at the beginningof 2020 was $17.1tn, a substantial increase
from 2018.155 A study of the European
market as at the end of 2019 found thatup to 45 per cent of total AuM managed byasset managers in Europe (roughly $13tn)
were invested in ways that take some sortof account of ESG factors.156 Meanwhilea survey of investors representing $25tn
in AuM during 2020, undertaken byBlackRock, found that these investors plan
to double their ‘ESG assets’ in five years.157
In a PwC survey of European institutional
investors during 2020, 75 per cent indicatedthat they plan to stop buying European
non-ESG products within the next two
years.158 Sustainable investment has also
been growing in China but is at an earlier
stage.159 For example, the number of panESG mutual funds in China at the end of
November 2019 was reported as accounting
for just under 2 per cent by AuM of allequity/hybrid funds in the market.160
141

These figures seem to suggest thatsomewhere between a third and a half ofglobal AuM is, or will soon be, managed ina way that somehow intentionally takes
account of sustainability factors. However,the fact that AuM are not included in thesefigures does not mean that sustainability
factors are being ignored in relation toother assets. For example, as noted above,signatories to the PRI’s Principles for
Responsible Investment (who therefore
commit to incorporate ESG issues into theirprocesses and practices), were managing
AuM in excess of $103tn in aggregate as ofApril 2020.

3.3.2

Sustainable investing – use ofinvestment powers

142

As noted, the ‘sustainable investing’umbrella shelters a multitude ofinvestment approaches. For example,
GSIA’s 2018 review identifies the different
approaches set out in the table below
which involve the use of investment
powers, providing an estimate of the AuM
subject to each approach. The categories

are not legally defined and there could be
differences of understanding as to what is
involved in each. However, they provide anindication of the prominence of different
sorts of sustainable investment approachin terms of AuM allocated. That said, there
is a limit to what these figures reveal
about levels of IFSI AuM since the defining
feature of that is pursuing assessable
sustainability impact goals more than theapproach used to achieve them. As noted inPart A.1.4, it would potentially be possible
to use any of these approaches as part of an
IFSI strategy.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

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Strategy161

Estimated global AuM allocated to it in US$ as at 2018

GSIA description

Negative/exclusionary screening$19.8tn

The exclusion from a fund or portfolio of certain sectors,
companies or practices based on specific ESG criteria.

Positive/best-in-class screening$1.8tnInvestment in sectors, companies or projects selected for positive
ESG performance relative to industry peers.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION

Norms-based screening

ESG integration$4.7tn$17.5tn

Screening of investments against minimum standards of businesspractice based on international norms, such as those issued by theOECD, ILO, UN and UNICEF.

The systematic and explicit inclusion of ESG factors into financial
analysis.

Sustainability-themed investing$1tn

Investment in themes or assets specifically related to sustainability(for example clean energy, green technology or sustainableagriculture).

Impact/community investing (see note below)$0.4tnTargeted investments aimed at solving social or environmental
problems, and including community investing, where capital isspecifically directed to traditionally underserved individuals orcommunities as well as financing that is provided to businesses
with a clear social or environmental purpose.

1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1

Note: the last of these categories conflates two different sorts of activity. ‘Impact investing’ is broader than (but could include forms of) ‘community investing’, and the concept of IFSI
is broader than both.

Appendix 2
Appendix 3
Supplement to Appendix 3

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143

Over recent years, there has been an
increase in the number and use of‘sustainability indices’ – essentially,
indices that comprise investments that are
selected based on positive sustainability
criteria. Some of the largest are the
MSCI KLD 400 Social Index (launched
in 1990), the STOXX Global ESG Leaders
Index (launched in 2011), the Dow Jones
Sustainability Indices (launched in 1999)
and the FTSE4Good Index (launched in2001). We have considered the index
descriptions for a number of indices ofthis sort to assess whether an investor
tracking the relevant index could be said
to be investing for sustainability impact,
and, hence, whether this could help tothrow light on the level of AuM currently
being invested for sustainability impact. On
the basis of the index materials reviewed,
the indices considered could generally beviewed as corresponding with one or otherof the sustainable investment approaches
mentioned in the table above. However,none of them obviously involved intentional
and assessable sustainability impact.

3.3.3

Sustainable investing - stewardship144

As noted in Part A (Section 1.2.3(b)),
stewardship is one of the ways in whichinvestors can seek to invest for sustainability
impact. Stewardship activity is widespread,but it is less clear how much of it would bewithin the scope of IFSI. Stewardship may
include addressing sustainability concerns,
but not necessarily.162 The GSIA research
discussed above suggests that as at 2018,
investors controlling some $9.8tn AuM
were engaging in stewardship activities
for sustainability purposes.163 However,this may understate the extent to whichinvestors are undertaking sustainabilityrelated engagement activity. For example,
signatories to the Principles for Responsible
Investment commit to be ‘active owners’
and incorporate ESG issues into their‘ownership policies and practices’ (Principle2) and, as noted above, they were estimatedto control in excess of $103tn AuM as at theend of March 2020.
3.4

IFSI AuM

145

For the reasons already given it ischallenging to estimate the levels of AuM
that are currently being managed in a waythat would be within the scope of IFSI.164
However, it seems reasonable to supposethat it makes up an element of the estimatesof sustainable AuM discussed above.

3.4.1‘Impact investing’ AuM

146

Most forms of what is often understoodby ‘impact investing’ would fall within
the scope of IFSI, although the focus of
IFSI is broader (see Part A.1.3). Levels of
AuM committed to impact investing could
therefore help to provide a floor for thelevel of AuM currently being invested inways within the scope of IFSI. However,there are no comprehensive statistics for
impact investment AuM.165 Some of themost commonly referenced figures areproduced by GIIN. Their 2019 survey of 279
impact investors found that the investors
surveyed were managing AuM of $404bn.166
They estimate that aggregate AuM of those
involved in impact investing as at the endof 2019 was $715bn.167 Meanwhile, the IFC
has estimated the AuM subject to impact
investing to be $505bn.168

ACKNOWLEDGEMENTS

3.4.2 AuM within scope of IFSI more broadly
147

148

Since the concept of IFSI is broader than
impact investing, the figure for AuM
managed in ways that are within the scopeof IFSI will be higher than these estimates.
In terms of the use of investment powers,
work undertaken by the PRI identified
465 investors that had allocated $1.3tn to‘impact-related investments’ worldwide
during 2016, up from 280 investors and$800bn in 2014.169 If that rate of growth ininvestment has continued, the aggregate
figure, including investments in prior years,
could now be materially larger. Nonetheless,the IFC has recently conjectured that the
total figure is somewhere in the range
between $505bn and $3.5tn (including DFI
assets and assets where impact is sought
through stewardship).170
However, IFSI is not restricted to the use ofinvestment powers, and these figures may
not fully reflect AuM subject to stewardshipwithin the scope of IFSI. Almost inevitably,
stewardship involves some articulationof goals which become the subject ofengagement. Much stewardship does not
specifically concern the sustainability
impact of investee enterprises. However,analysis of shareholder action and attitudes
suggests that social and environmental
factors are an increasingly significant areaof concern.171

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

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149

The levels of AuM controlled by investors
engaging in stewardship who havecommitted to take ESG factors into accountin their activities, noted at Section 3.3.2
above, are significantly higher than thecapital allocation figures just discussed(so much so that, for some, it raises
the question of why there has not been
more change). This may suggest thateven if portfolios are not currently being
invested in assets that can be classed as‘impact-related’, other aspects of existing
investment practice are nonetheless tosome degree consistent with IFSI. Becauseof that, the AuM managed by investors

that have subscribed to investor coalitions
and networks that commit them to taking
steps that would potentially fall within thescope of IFSI may provide a better guide.
The commitments in relation to achieving
net zero greenhouse gas emissions by
2050 or sooner given by signatories to the
Net Zero Asset Managers Initiative andthe Net Zero Asset Owners Alliance areparticularly goal-orientated. Membersof these coalitions control AuM of $43tn
and $6.6tn respectively.172 Climate Action
100+ signatories operating as an investorled engagement network control AuM of$54tn.173

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
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4.

IN WHAT WAYS DO PEOPLE WANT THEIR ASSETS INVESTED TO BRING ABOUT SUSTAINABILITYIMPACTS?

4.1

Introduction

150This section comments briefly on an
increasing body of industry, not-for-profit
and government surveys and academic
research investigating the attitudes ofindividual investors towards sustainability
factors in the investment process.

151

152

People’s views on this topic can be relevant
to what legal rules require or permit asset
owners to do in managing portfolios (seePart B.3). They also have a bearing on
the policy options considered in Part C.3,
for example, where pursuing people’s
sustainability aspirations could advancepolicy objectives.
We have therefore looked at much of therelevant material published since 2017 andour assessment based on those materials
is summarised in Part A, Appendix 3.174
Although we have not undertaken a fullliterature review, our focus has been on:• whether, based on the available

materials, individuals say they wantsustainability factors to be reflected in
the way their investments (or those outof which they will receive benefits) aremanaged (Appendix 3, Section 1);• evidence on what motivates individual

investors, and particularly the balance
between the goals of optimising financial
return and achieving sustainability
impacts (Appendix 3, Section 2);• evidence for the effect of individuals’

these issues, and given the relevance of this
topic, the matters covered by this section
would benefit from further in-depth work(see Part C.2).

attitudes on their investment decisionsin practice, (Appendix 3, Section 3); and• possible reasons for any difference

between stated attitudes and practice(Appendix 3, Section 4).
4.2

Summary findings

153

The studies provide helpful insights onthese matters. However, they need tobe approached with care. The topic iscomplex. Attitudes and practice vary
between individuals, and between
jurisdictions and cultures, and the picture
given by the materials is partial. Studies ofthis sort also have potential limitations, forexample in terms of their methodologies
and design, question framing, differencesof understanding about the concepts
involved, and the size and compositionof the groups surveyed. Particularly withinvestment industry surveys, it is notalways clear how these matters have beenaddressed. Further, many of the studies are‘attitudinal’, reporting individuals’ views
on sustainability and investment, rather
than looking at what they do in practice.
There is a well-recognised difference
between what people say and what they
do.175 However, studies are increasingly
looking at how far the two coincide, using
behavioural experiments or based on
observed behaviour. A summary of someof the more obvious potential issues withthe available materials is included in the
Supplement to Appendix 3. In view of154

Subject to these qualifications, there
are nonetheless some significant
recurring themes.
• Most, but not all, people covered by thestudies (commonly at least half, andoften nearer three-quarters), express
sustainability aspirations of some
sort in relation to their investments.
These aspirations may be more marked
among younger generations and may
have strengthened in the light of the
COVID-19 pandemic. Some studies alsosuggest that women may be more likely
to consider sustainable investing.
• Both optimising financial return byintegrating sustainability factors
and achieving positive sustainability
outcomes (or at least aligninginvestments with sustainability values)
seem to be significant motivations. Part
A.1 distinguished between instrumental
IFSI and ultimate ends IFSI, in terms ofthe goals investors pursue in managing
assets. In many surveys, a significant
number of participants seem to expectthat the integration of sustainability
factors in the management of theirinvestments will improve financial
returns. For some, this appears tobe their main reason for wanting it.
However, there is evidence that many, if

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?

Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
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ANNEXESGLOSSARY

REFERENCES

52

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not most, are also motivated by broader
sustainability-related goals in relation
to at least some of their assets. This
would be consistent with a wider bodyof research on human values and on the
motivations of those who have madesustainable investments. A significant
group of these may be hoping to ‘do goodby doing (or feeling) well’. Nonetheless,in some studies, a material numberof participants suggest they would be
willing to accept some risk to financial
return to pursue their aspirations.

investment AuM, the levels of assets
committed to ‘sustainable’ investment
approaches are lower than might be
expected based upon the expressed
preferences described above. There may
be various reasons for this, including
the commonly encountered difference
between what people say and do, andinvestor inertia (since achieving greateralignment could involve revisingexisting investment arrangements).
However, there is also a possibility thatinvestors are not being given adequate
information or prompted to consider
their sustainability aspirations in theprocess of selecting investments.

• There is good reason to think that many

people who say they want sustainability
factors to be taken into account expectthat to bring about positive changes in thesustainability impact of business activity.
• The precise extent to which people’s

sustainability aspirations are related tofinancial goals, the time period people
have in mind, and the level of any
trade-off people are prepared to make topursue sustainability goals, and which
ones, and in relation to what portion of
their assets, remains unclear. It is likelythat there are motivational overlaps andspectrums in terms of strength.
• Nonetheless, the level of AuM

committed to sustainable investment
approaches has been growing sharply,
and there is evidence of a correlation
between positive sustainability attitudes
and the investment decisions people
take in practice. Some of it also seems
to confirm that some investors areprepared to risk lower financial returns
to pursue sustainability goals.

ACKNOWLEDGEMENTS• In spite of the growth in sustainable155

If borne out by further work, thesefindings could lend support to policy
moves, among other things, to encourage(a) investment approaches within thescope of IFSI and (b) greater attention toreflecting individual investors’ views on
sustainability in the regulatory framework
for institutional investors who manage
their assets.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?

Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
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ANNEXESGLOSSARY

REFERENCES

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APPENDIX 1ACKNOWLEDGEMENTS

Brief summary of the historical origins ofsustainable and impact investing

156

157

Religious groups have long espoused
ethical or faith-based investment
approaches. Efforts by US Methodist andQuaker groups in the 18th century to
refrain from investment in companies
profiting from war or slavery are widely
cited as early examples of ethicalinvestment.176 The use of divestment asa tool of opposition against corporate
connections to the Vietnam War, apartheidin South Africa, and other politicalsituations in the 1960s–1980s led to thedevelopment of a contemporary socially
responsible investment movement.
Religious coalitions, NGOs and otherconcerned investors used screening andshareholder activism to exert influence
over corporate conduct. In the 1990s andearly 2000s, socially responsible investment
became infused with a greater regard forenvironmental issues, transitioned to amore professionalised practice, and began
to become integrated into mainstream
investment practice.177
This move was aided by the developing
view in parts of the investment sector
that integration of ESG factors could be
important in protecting, and potentiallyeven enhancing, the financial performanceof investment portfolios. One of theearliest attempts to understand thefinancial materiality of ESG factors wasundertaken by a working group set up
in 2003 by the UNEP FI. Together with anumber of finance firms, it published aseries of research reports in 2004 whichwere influential in focusing attention
on the matter.178 Also in 2004, in the UN
Global Compact’s report Who Cares Wins, acoalition of leading financial institutions
endorsed the view that companies thatconsider ESG issues are more equipped to
manage their risks and deliver shareholder
value.179 Following that and the 2005
Freshfields Report on the integration of
ESG factors in the investment process asa legal matter,180 ESG gained traction asa strategy, with an increasing numberof institutional investors stating they
integrate ESG considerations into theirpursuit of financial return.181 Part of theimpetus for this was a joint PRI, UNEP FI
project, Fiduciary Duty in the 21st Century,
supported by The Generation Foundation,
which identified the integration of ESG
issues as an increasingly standard part of
the regulatory and legal requirements for
institutional investors.
158

Impact investing, a term reportedly
coined at a conference convened by theRockefeller Institute in Bellagio, Italy, in
2007,182 emerged as a disruptive practiceon the border between philanthropy
and investment.183 At first it was largely
confined to foundations, development
finance institutions, and family offices
as a specialist investment approach.184
As recently as 2015, the OECD described
the social impact market as being in its
early stages.185 However, while accurate
data is in short supply (see Part A.3),
there are signs that it has begun to moveinto the investment sector mainstream.
It is also becoming more sophisticatedas an investment approach.186 Amongother things, these developments havebeen fostered by the various impact
investing bodies mentioned in Part A.1.3,
and a number of specific impact-focused
initiatives, including from the G8 during
the UK’s presidency in 2013187 and, aroundthe same time, from the World Economic
Forum.188 Indeed, recent years have seen
the beginnings of a confluence between ESG
integration and a more holistic approachto realising economic goals and positivesocial and environmental outcomes.
Proponents of ESG integration haveincreasingly emphasised the importance ofmoving beyond a ‘do no harm’ risk-based
approach to ESG to a more proactive notionof business activity where enterprises(and investors without an explicit impact
investing mandate) seek to create sharedfinancial and societal value.189
159

The Sustainable Development Goals,
and the Paris Agreement, by identifying
common goals, have helped to focus
attention on the social and environmental
outcomes of human activity, including
investment, in addition to investment
return. At the same time, governments
have increasingly recognised that achieving
them lies beyond the scope of government
action alone, so have begun to looktowards private finance and investment.
Meanwhile, the investment market ischanging rapidly and there are now strong
indications of a growing desire among
investors to discharge their duties in waysthat further sustainability goals.190

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1

Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
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REFERENCES

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APPENDIX 2ACKNOWLEDGEMENTS

Key sustainable investment concepts

EXECUTIVE SUMMARY

Sustainable investment-related concept

Example of definition

ESG (Environmental, Social and Governance) investing/integration

The explicit inclusion by asset managers of ESG risks and opportunities into traditional financial
analysis and investment decisions based on a systematic process and appropriate research sources.191

Ethical investing

Broadly, the integration of personal values, social considerations and economic factors into theinvestment decision.192

Responsible investment

A strategy and practice to incorporate environmental, social and governance (ESG) factors ininvestment decisions and active ownership.193

Socially responsible investment

A generic term covering sustainable, responsible, socially responsible, ethical, environmental,social investments and any other investment process that incorporates environmental, social andgovernance issues.194
An investment is considered socially responsible because of the nature of the business the company
conducts. Common themes for socially responsible investments include avoiding investment incompanies that produce or sell addictive substances (like alcohol, gambling and tobacco) and seeking
out companies engaged in social justice, environmental sustainability and alternative energy/clean
technology efforts.195

Sustainable investing

Sustainable investment practices share the concept of a long-term oriented investment approach,which integrates ESG factors in the research, analysis and selection process of securities within an
investment portfolio. It combines fundamental analysis and engagement with an evaluation of ESG
factors in order to better capture long term returns for investors, and to benefit society by influencing
the behaviour of companies.196
Sustainable investing is an investment approach that considers environmental, social and governance(ESG) factors in portfolio selection and management. For … articulating our shared work in the
broadest way, GSIA uses an inclusive definition of sustainable investing, without drawing distinctions
between this and related terms such as responsible investing and socially responsible investing.197

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2

Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

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APPENDIX 3ACKNOWLEDGEMENTS

In what ways do people want their assets
invested to bring about sustainability impacts?

1.

What do individual investors say they
want?

160

162

Essentially, there are two issues fromthe point of view of this report. Do those
covered by the studies indicate:

An increasing body of industry, notfor-profit and government surveys andacademic research has investigated theattitudes of individual investors towards
sustainability factors in the investment
process. We have looked at much of therelevant material published since 2017 andour assessment based on those materials
is summarised in this Appendix. Although
we have not undertaken a full literature
review, our focus has been on:• that they want sustainability factors to

be taken into account in the way theirassets (or the assets out of which theirbenefits will be paid) are managed (seeSection 1.1 below); and• that they want this to happen in a

way that achieves positive or reduces
negative sustainability impacts (see Section
1.2 below)?

• whether, based on the available material,

individuals say they want sustainability
factors to be reflected in the way theirinvestments (or those out of which
they will receive benefits) are managed(Section 1);• evidence on what motivates them, andparticularly the balance between thegoals of optimising financial return andachieving sustainability impacts (Section 2);• evidence for the effect of individuals’

attitudes on their investment decisionsin practice, (Section 3); and• possible reasons for any difference

between stated attitudes andpractice (Section 4).
161

The studies provide helpful insights onthese matters. However, they need to beapproached with care. A summary of someof the more obvious potential issues withthe available materials is included in the
supplement to this Appendix.

Another sustainable investment surveyof US individuals by Allianz found that79 per cent were positive about investingin a company that cares about thesame issues as they do.201 A survey ofDutch pension fund beneficiaries foundapproximately 75 per cent in favour ofsustainable investment.202 In a surveyof French retail investors, 72 per centof participants wanted ‘integration ofsustainability issues in their savings funds
to be mandatory’,203 while another surveyof French and German investors, by the 2˚
Investing Initiative, indicated that between
65 and 85 per cent wanted to invest moresustainably.204 In a poll of Australians, 9 in
10 participants expected their money to
be invested ‘responsibly’ and ‘ethically’.205
Two cross-jurisdictional studies present asimilar picture, covering the jurisdictions
above but also jurisdictions in Asia, theMiddle East and South America.206

1.1

Taking sustainability factors into
account

163

In most of the surveys seeking views on
the point, at least half of the participants,
and often nearer three-quarters,
indicate that they have some interest in
sustainability factors being taken into
account in how their money is invested.198
For example, the UK Department forInternational Development surveyed
6,000 UK individuals for its ‘Investingin a Better World’ project. 70 per centof respondents said they wanted theirinvestments ‘to avoid harm and achieve
good for people and the planet’, and 64
per cent said financial institutions should
avoid investing in companies that harmthese.199 A survey of US individuals withinvestible assets of at least $100,000 for theMorgan Stanley Institute for Sustainable
Investing found that 85 per cent wereinterested in sustainable investing.200

164

These attitudes may have strengthened as aresult of the COVID-19 pandemic, especiallyin relation to social sustainability.207
Significantly, in terms of future investment
decision makers, interest may beparticularly strong among Millennials.208

1.2

Do the studies suggest that individuals
want to achieve a sustainability
impact?

165

Surveys generally do not address how
investors wish sustainability factors to bereflected in the way money is invested.
Wanting them to be taken into accountis not necessarily the same as wanting

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

56

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to make a positive difference to thesustainability impact of an investee. For
example, a person may simply be seeking
risk mitigation. However, the survey
materials tend to suggest that a significant
portion of participants want to improvebusiness sustainability impacts throughtheir investment decisions.
166

For instance, in the survey of French retailinvestors mentioned above, around halfof participants said that they ‘care about
the environmental and social impacts of
their decisions.’209 In one international
study, 80 per cent considered it important
to invest in ‘ethically’ run companies, and72 per cent wanted to invest in companies
with a ‘positive social impact and … goodenvironmental records.’210 In anotherstudy of 25,000 individual investors
internationally, 60 per cent of respondents
considered that their individual choiceof investment can make a difference forbuilding a more sustainable world.211 84
per cent of US investors covered by the
Morgan Stanley Institute for Sustainable
Investing survey mentioned above said
that they wanted to receive an ‘impact
report’.212 75 per cent of US individuals
surveyed on behalf of the Natixis Center
for Investor Insight said that it was‘important to make the world a better
place while growing their personal
assets.’213 In one survey of UK individuals,
only 8 per cent disagreed with thestatement: ‘I would like my investments to
do some good as well as provide me witha financial return.’214 In another, 57 percent of participants thought it importantto take account of a company’s social andenvironmental impact, rather than justthe potential financial gain,215 in deciding
whether to invest, while in another, 61
per cent of participants said that for the
economy to succeed in the long term
‘investors need to support progressive
businesses tackling the big issues weface.’216 In a survey of German mutual fundinvestors, 86.4 per cent of those who had
invested in ‘socially responsible’ funds and80.8 per cent of those who were interested
thought that an ‘ethical fund’ should
influence companies through engagement
to achieve greater social responsibility.217 In
an academic survey of Swedish individuals
who had invested in ‘ethical funds’, when
asked whether ethical funds should ‘try
to make the world a better place’ by
influencing companies, only 9.5 per centanswered ‘no’.218
167

However, in some cases, survey questions
address the matter of impact more
explicitly. Again, responses suggest thata significant portion of those surveyedwished to achieve a positive impact
through the way their money is invested.
The survey of French and German retailinvestors mentioned above found thatas many as 40 per cent of participants
wanted to achieve positive outcomes, witha further 20 per cent more moderately
inclined towards action to achieve
similar outcomes.219 The survey report
also suggests that the clearer the link
between investing and achieving specificimpacts on behaviour, the stronger the
motivation is likely to be.220 A separate
survey of German individuals found asimilar association.221 The 70 per cent of UK

individuals covered by the UK government
survey mentioned above who wanted theirinvestments ‘to avoid harm and achieve
good for people and the planet’ seem tohave been contemplating some sort of
impact. The study also found that mostpeople would be motivated to save more if
they knew their savings and investments
made a positive difference: 52 per centon average, rising to 60 per cent for thosewith investible assets of over £25,000 and
67 per cent for Millennials.222 80 per centof the affluent US individuals participating
in a survey by Nuveen said that theirinvestments should strive to make apositive impact on society.223 Meanwhile,in one of the studies of Dutch pension
fund beneficiaries mentioned above, 67.9
per cent were in favour of ‘increasing thepension fund’s engagement to increase thesustainability of the companies in which
it invests’.224
2.

What motives lie behind expressed
preferences?

168

Many of the survey participants seemto have wanted sustainability factors to
be taken into account. However, there
is a separate question as to why theymight want this. The answer could be
relevant both to asset owners in seeking
to discharge their duties or exercise
discretions (Part B.3) and to policy options
in relation to IFSI (Part C.2).

169

Part A.1 made a key distinction between
two sorts of IFSI, depending upon investors’
goals: instrumental IFSI involving the
pursuit of sustainability impacts with aview to achieving an investor’s financial

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

57

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

goals; and ultimate ends IFSI involving the
pursuit of sustainability impact goals as
ends in themselves. A similar differenceof motivation was highlighted in Part
A.1.4 in relation to sustainable investing
more broadly, with investors wishing tohave sustainability factors reflected in the
management of their portfolios either to
optimise their financial return or to alignthem with their wider values.
170

Survey responses also reflect these two
sorts of motivation while much of theacademic research seeks to clarify the
relationship between the two. Together,
they suggest that optimising financial
return (see 2.1 below) and achieving
positive sustainability outcomes oralignment with a person’s sustainability
values (see 2.2 below) are both significant
motivating factors. Survey participants’
responses commonly indicate that theyprioritise the former, as does some of theresearch. However, some studies suggestthat investors may be prepared to incura degree of financial risk to achieve
their sustainability goals. As noted inPart A.1.1, these motivations cannot becompartmentalised. Many people are likely
to experience both simultaneously, andunsurprisingly therefore the materials
reviewed do not always distinguishclearly between them or place people intoneat categories.

2.1

Financial return as the goal

171

Some of those covered by the studies
wanted sustainability factors to be taken
into account because they thought itwould improve their financial prospects.

For example, in one survey of affluent US
investors, 53 per cent gave performanceas their main motivation for investing
responsibly.225 A survey of UK investors
found that 47 per cent considered it agood way to make money (although 54 percent also wanted to give something backto society and 53 per cent to be consistent
with their values).226 In another UK
investor survey, 68 per cent believed thatcompanies with more robust ESG practices
would be in a better position in the longrun (although this was the study, noted
above, in which 57 per cent thought it
important to take account of a company’ssustainability impact, not just thepotential financial gain).227 In the survey ofFrench and German investors mentioned
previously, 10 to 15 per cent wished to
optimise returns using ESG.228
2.2

Sustainability goals: doing well by
doing (or feeling) good, and beyond

172

The surveys are generally more ambiguous
about the relationship between thefinancial and wider motivations of thoseconcerned. However, the responses
discussed at 1.2 above suggest that survey
participants often regarded sustainability
goals as important.

173

The presence of ‘pro-social’ motivationsof this sort is consistent with academic
research on the motivations of thoseinvesting in ‘socially responsible’ or‘sustainable’ investments. There isconsistent evidence of a positive association
between stronger social values and thelikelihood of people holding investmentsof this sort.229 A similar correlation has also

been found among those who were simply
interested in investing ‘sustainably’, but
had not yet acted on their interest.230 As
noted at 1.2 above, there is reason to thinkthat these motivations may be stronger
where people believe that they can makea positive social or environmental impact
with their investments.
174

Some academic studies have suggested
that these social values are, at least in partor for some investors, characterised bythe ‘warm glow’ derived from performing
the act of investment more than theextent of any impact on the welfare issues
concerned.231 So long as an investment
appears to have some impact, stronger
social values may not always result in aperson investing a greater proportion of
their assets ‘sustainably’ or focusing on
the level of impact of their investment.232
This could result in a greenwashing risk,
where ‘sustainable’ financial products aredesigned to provide ‘warm glow’ morethan impact. If so, this could reduce theinfluence of investors’ socially orientatedaspirations in actually addressing
sustainability goals.233

175

The presence of ‘pro-social’ or ‘otherregarding’ motivations also resonates withwork on human values and motivations
more generally both in an economic
context234 and beyond.235

176

Nonetheless, there is still a question
about how investors prioritise between
sustainability-related goals and achieving
a financial return.236 Three themes emerge
from the studies:

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

58

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION• the possibility of ‘doing well by

doing good’;(b) Sustainability, but prioritising financial return179• people who have sustainability goals but

who prioritise financial return; and• those willing to risk lower financial

return to pursue sustainability goals.
177

These three potentially overlap, forexample, because a person may be willingto incur a heightened risk in relation tosome but not all their assets.

(a) ‘Doing well by doing good’178

Many survey participants may haveviewed ‘making a positive difference’and ‘earning a financial return’ as
connected. For example, in the Morgan
Stanley Institute for Sustainable Investing
survey mentioned above, 86 per cent took
the view that corporate ESG practices
potentially increase profitability, but 84 percent nonetheless wanted to tailor theirinvestments to their values.237 Likewisein the Natixis survey mentioned above,
75 per cent of participants said it was
important to make the world a better
place while growing personal assets, with
74 per cent seeing ‘responsible investing’as sound financial sense.238 Similarly, theAllianz survey of US investors discussed
above found that 74 per cent believed that
ESG investments were both a strategy
they could feel good about and one thatmade long-term financial sense.239 Similar
motivations seem to lie behind the surveyof UK individuals in which only 8 per centdisagreed with the statement: ‘I would likemy investments to do some good as well as
provide me with a financial return.’240

180

However, survey participants often seem torecognise that financial and sustainability
goals can conflict. For many, their desire
to pursue sustainability-related goals
may be limited if it could negatively
affect their financial goals. For example,
half of the individuals surveyed in one
international survey during 2019 indicatedthat they wanted their investments‘aligned with their values, but not at thecost of investment performance.’241 The
Allianz survey of US investors mentioned
previously found that 77 per cent would
reduce money in an ESG investment if it
was underperforming.242 In the survey ofGerman mutual fund investors mentioned
above, those invested or interested ininvesting in ‘ethical’ funds had limited
appetite for sacrificing financial return
to influence companies to become more‘socially responsible’.243
Surveys also sometimes address therelationship between financial andsustainability goals when they ask
investors to rank by relevance to themfinancial factors alongside wider goals
related to sustainability. In the Schroders
2019 Global Investor Study mentioned
above, the majority of respondents weremainly focused on financial return.244 This
is in line with a BNP study covering fiveEuropean jurisdictions, where the criteria‘safety’ and ‘returns/income’ ranked top,and ‘social/ethical/ecological criteria’ranked last.245 Nonetheless, a majority ofparticipants in all jurisdictions expressed
a willingness to invest at least a small partof their portfolio in ‘socially responsible

ACKNOWLEDGEMENTS

investments’.246 Several studies covering
the UK have produced similar results.247

EXECUTIVE SUMMARY(c) Incurring financial risk to pursue
sustainability goals

181

Finally, some surveys suggest a willingness
among participants to risk a reduction
in financial return, at least in relation toa part of their investments, to integratesustainability factors. For example, in thesurvey of Dutch pension fund beneficiaries
mentioned above in which 67.9 per cent ofrespondents supported greater inclusion ofsustainability factors in the managementof the fund through increased stewardship,
among those who believed that thechanges would mean lower financial
returns, 58.8 per cent nonethelesssupported the change. Support remained
strong even after the fund had changed
its engagement strategy.248 Meanwhile, theother Dutch pension fund study mentioned
above found that roughly three quartersof those members responding supported
a more sustainable investment policy
even if this could negatively affect theirpremium or pension (on a range of 1 to 6,‘completely disagree’ to ‘strongly agree’).249
One of the studies of UK investors
mentioned previously found that a‘substantial number are prepared to tradeoff finance and social outcomes.’250 In the2020 Schroders Global Investor Study, 77
per cent of participants indicated that theywould not ‘invest against their personal
beliefs’, although it is unclear what they
meant by this since many seemed to havethought that addressing sustainability
concerns and financial goals are largely

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

59

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTIONaligned. Of the remaining 23 per cent, ‘theaverage return on their investment would
need to be 21 per cent to adequately offset
any guilt.’251
182

It is generally unclear from the surveys
how much additional financial risk
investors in this category are prepared
to undertake. However, some academic
studies have found evidence that people
are prepared to act on sustainability
preferences even if they perceive apotential financial risk. These are discussed
at 3 below and in some cases do address
the issue of how much financial loss an‘average’ investor is prepared to risk.252

3.

What do investors do in practice?

183

As noted, there is a difference between
what people say and what they do. Do thesort of attitudes described above affect how
people invest? There are essentially two
ways of trying to answer this:are circumstances that result in them notrealising their aspirations. The second ofthese possibilities is discussed further in
Section 4 below. If there are circumstancesof this sort, this is likely to be of interest
to policymakers, especially if those
aspirations align with policy goals and thisis discussed further in Part C.2.
3.1

186

• by undertaking behaviouralexperiments.

185

In both cases, there is evidence of acorrelation between attitudes and action.
Some of it also seems to confirm that
there are investors who are prepared torisk lower financial returns to pursue
sustainability goals.
However, the levels of assets committed to‘sustainable’ investment approaches arelower than might be expected based upon
the expressed preferences described above.
There is therefore a question as to whether
that is because what people say is notreally what they want, or whether there

Actual fund flows towards ‘sustainable
investment’

Growth in ‘sustainable investment’• by examining actual fund flows; and184

a positive feature. Money moved towards
funds with high ratings and away fromthose with low ratings.255 Experimental
testing designed to illuminate the motivesof the individuals involved suggested
a mix of financial return and ‘nonfinancial’ considerations.256 Morningstar
subsequently introduced a ‘Low Carbon
Designation’ for mutual funds in 2018.
That was followed by a substantial increasein monthly net flows to LCD funds relative
to conventional funds. Although LCD funds
could be expected to have lower exposure
to climate change risks, lower portfolio
diversification meant that they also
displayed substantially higher idiosyncratic
volatility. Investment would therefore
seem to have involved some form of tradeoff.257 Looking at the portfolio choices ofmore than 900,000 French pension fundbeneficiaries, the introduction in Franceof a requirement on certain pension
funds to operate ‘solidarity funds’ (witha social and ESG emphasis) as an option
for beneficiaries was connected with a 2.1
per cent higher equity allocation by plan
participants, driven by actual investments
in responsible equity funds.258 Thesesolidarity funds are discussed further in
the French legal memorandum, includedin the annexes, and are an example ofultimate ends IFSI.

187

The considerable growth in AuM
committed to ‘sustainable investment’ (seePart A.3) suggests that attitudes of the sort
described above do influence investmentin practice. A significant portion of
the assets included in these figures aremanaged by institutional investors, notindividuals. Nonetheless, some are directly
invested by individuals (as sustainabilityrelated investment marketing to the retailmarket confirms), and the beneficiaries of
institutional investors are often individuals
whose views may have influenced theirdecisions. The fact that some of theseinvestments are in funds that apply‘ethical’ screening suggests that at least
some investors are willing to risk financial
loss to pursue broader goals.253 In the
study of Swedish ‘ethical’ fund investors,
mentioned above, 66 per cent suggested
they were willing to sacrifice at least somefinancial return.254
Research provides further support. A
study of how US mutual fund investors
responded to Morningstar’s introduction ofsustainability ratings in 2016 suggests that,collectively, they viewed sustainability as

Asset flows fall short of the levels of interest suggested by
the studies above
188

While the studies discussed at 1.1 above
suggest a desire among a significant groupof individual investors for sustainability
factors to be taken into account in theway their money is managed, there is also

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

60

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

evidence that what happens in practicefalls short. For instance, in the BNP Paribas
survey mentioned above, while between
52 per cent and 80 per cent (dependingon the jurisdiction) of respondents werewilling to invest at least a small portionof their assets in ‘socially responsible
investments’, only between 5 per centand 7 per cent of those surveyed did so at
the time.259 Among respondents to the UK
Department for International Development
study, mentioned above, only 13 per centsaid that they currently hold a sustainable
investment.260 Similarly, in a UBS study
involving 5,300 high net-worth investors
from 10 different jurisdictions, 65 percent believed it was highly important tohelp create a better planet, but only 39 percent had ‘sustainable investments’.261 The
Allianz survey of US investors mentioned
above also found that ‘a significant
gap exists between what people say isimportant and how they actually invest.’262
3.2

Experiments testing priorities between
financial and sustainability goals

189

While the issue has so far received only
limited attention from researchers,some studies have sought to test, morescientifically, what people do wheninvesting their own money.

190

Some suggest a prioritisation of financial
over sustainability concerns. For example,
one experiment looked at the decisionsof clients of a Norwegian bank investingin mutual funds. Some clients received
communications framing decisions onwhether to invest ‘responsibly’ in terms offinancial benefits, others communications

that emphasised moral concerns.
‘Financial’ framing had a more significant
impact on investment behaviour than‘moral’ framing. Yet both sorts of framing
resulted in higher levels of engagement
in responsible investment compared withinvestors in a control group who received
no communication.263
191

192

However, some studies have revealed
evidence of a ‘willingness to pay’ forsustainability, suggesting, consistent withthe studies mentioned above, that there
are investors who are prepared to incursome financial risk in order to pursue
sustainability-related aspirations.
In particular, one study of a representative
sample of US investors by researchers
from Cambridge University found that themedian investor was willing to sacrifice up
to 2.5 per cent in return for a sustainable
investment.264 Another study, this time ofGerman investors, suggested participants
would be willing to sacrifice an averageof 0.21 per cent in financial return fora more sustainable investment product,
and that environmental and social values
were strongly associated with willingness
to pay.265 Another study of individuals
recruited through Amazon’s Mechanical
Turk suggested that participants werewilling to pay $0.70 more for a share ina firm giving one more dollar per shareto charities, while a company having anegative externality on a charity of a dollar
per share was valued $0.90 less than asimilar company with no externality.266
The Morningstar Low Carbon Designation
study mentioned above suggests thatsome investors were willing to accept

higher volatility in the interests ofreducing exposure to climate change risk
or otherwise.267 Finally, two experiments
involving Dutch investors have produced
evidence of a ‘willingness to pay’ forsustainable investments among investors,
in terms of reduced financial performanceor increased management charges.268
4.

193

194

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

Why the difference between
positive sustainability attitudes andinvestment practice?

INTRODUCTION
1.

What is investing forsustainability impact?

The apparent difference between thelevel of investor interest in ‘sustainable
investing’ and investment practice may
suggest that there are circumstances
surrounding the investment process that
result in individual preferences being
muted in some way. For example it ispossible that investors have not received
adequate information or been prompted
to consider how their sustainability
aspirations are relevant to investment
decisions, or that there has been a shortageof suitable products.269 Once investments
have been made there is then a range of
behavioural and structural factors that
could create inertia for those wishing toreflect their sustainability aspirations in
how their money is invested.270

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?

The materials reviewed do indeed suggestthat the difference can at least partly be
explained by structural factors of this sort.

Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

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Awareness of the relationship between investment
and sustainability
195

First, while awareness of a potential
relationship between investment andsustainability appears to be growing,
the picture is mixed. For example, the
BNP study mentioned above found thatawareness of the concept of ‘socially
responsible investment’ had increased
by at least 8 per cent between 2017and 2018 in Italy, France, Belgium andGermany.271 However, some surveys suggest
confusion and limited awareness of forms
of investment related to sustainability
factors.272 One recent study of the Japanesemarket identified a substantial information
deficit about sustainable investments,suggesting that sustainable investing inJapan remains in its infancy.273

Lack of information
196

Some surveys also suggest that inadequate
information may be an obstacle. For
example, while most of the investors
covered by the BNP survey had received
information about socially responsible
investment, it had come through the media,
whereas they would have preferred more
and in-depth information, preferably fromtheir bank advisers. Meanwhile, participantsin Schroders’ 2018 global investor survey
felt there was a lack of information aboutsustainable investments which was limiting
how much they invested, with Asian
individuals being most affected (61 per cent)and percentages in all jurisdictions in excess
of 50 per cent.274 The UK government survey
discussed above found that 58 per centwould be more likely to invest in sustainable

investments if they had more information
about them.275 There have been similarfindings in other surveys of UK investors.276
Conversely, the examples investor responses
to Morningstar ratings, discussed at 3.1
above, provide an indication of the impactthat sustainability-related information canhave on investor behaviour.277
Prompts in the investment process
197

Investors have not been routinely prompted
to consider their sustainability preferences
when making investment decisions. This
recognition lies behind changes to the EU
rules for investment advisers and managers
requiring them to gather information on,
and take account of, suitability goals inadvising their clients or making investment
decisions.278 A ‘mystery shopper’ exercise in
France for the survey of French and German
investors mentioned above found thatquestions about sustainability preferenceswere ‘almost never asked’, and when raisedby the client, the recommendations were
often not suitable.279 One of the UK studies
mentioned above found that 73 per cent ofrespondents had never been offered ‘ethical’
investment opportunities.280 In anotherstudy during 2020, 83 per cent of advised
investors indicated that they would value
a conversation about investing sustainably
but, on average, only 45 per cent of advisers
were having these conversations.281 This
divergence may reflect an assumption on
the part of advisers that their clients are notinterested, which does not sit comfortably
with the surveys discussed above.282 An
FT Adviser survey in 2019 found that over
one-third of the UK advisers who responded
would never offer an ESG fund and only

22 per cent always considered them.283
However, more UK advisers now seem to bemoving towards recommending them, partly
prompted by client demand.284 Nonetheless,a 2020 adviser survey by Schroders foundthat only 17 per cent would rate theirconfidence as very high when speaking toclients about investing sustainably.285
198

The role of financial intermediaries may
be important in enabling people to act
on their environmental preferences. One
study of Swedish households suggests thatthose with strong environmental values
were relatively financially disengaged, butthat there may be a connection between
greater financial literacy and the likelihoodthat those with strong environmental
values will invest accordingly.286 In theGerman mutual fund investor study
mentioned above, the two main reasons
given by investors who were interestedin ‘socially responsible’ funds for not yet
having invested were feeling insufficiently
informed and that their bank did notoffer them. They also felt that they had
insufficient knowledge.287 Financial
intermediaries may be able to help inclosing gaps of this sort.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

62

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION

SUPPLEMENT TO APPENDIX 3
Potential limitations of studies on investor
attitudes

199

The studies considered in this Appendix
provide helpful insights on investors’
attitudes and behaviour. However, theyalso have potential limitations.
• The concept of IFSI has been developedfor use in this project. There is therefore
little research on investors’ attitudes
to investment approaches specificallywithin the scope of IFSI.288 In view ofthat, we have looked at evidence on
whether investors want sustainability
factors (variously described) to betaken into account in the way theirinvestments are managed. As noted
in Part A.1.1.4, this is not necessarily
the same as wanting the relevant
investments managed in a way thatwould fall within the scope of IFSI. Thatsaid, as discussed in Section 1 of thisAppendix, survey reports often suggestthat participants want to make a positive
difference through their investments.
• Many of the studies are based onrelatively small sample sizes. In addition,
the group surveyed may not always be
representative of investors generally,
within the jurisdiction concernedor otherwise. The initial selection ofparticipants for a study, or subsequent
self-selection, can affect the results.289
For example, in some cases a survey
may have been focused on contacts ofthe firm undertaking the survey or aparticular sector of the market (suchas ‘mass affluent’ or ‘high net worth’).

ACKNOWLEDGEMENTS

In others, there may have been some
self-selection among respondents (ie thetype and number of participants that
respond), such as where those with aninterest in sustainability were more
motivated to participate and so havebeen disproportionately represented.
• Most industry surveys rely heavily on

self-reporting of attitudes.290 As noted,
there is often a difference between what
people say and do, including how they
invest. Further, a correlation between
what people say and how they invest
does not necessarily show there is acausal connection.
• More generally, the research approach

can have an important bearing on its
outcome and reliability. The surveys
considered appear to have deployed arange of approaches involving varying
levels of robustness. Since studies
have been prepared using varying
methodologies, they are not necessarily
easily comparable.
• Research on subjective matters, such as

investor attitudes, requires considerable
judgement, for example, as to whatquestions to ask, the context in which
they are asked and how they are framed(for example, whether sustainability
information about an investment ispresented positively or negatively291). These
factors can significantly affect responses.
It is, in any event, difficult to separateout different motivations, for example,
to establish whether people support

the integration of sustainability factors
because they consider them financiallymaterial or because they believe it canhelp in achieving sustainability goals, orthe balance of motivations between the
two. Studies of this sort therefore involve
an element of artificiality.
• As discussed in Section 1, the ways inwhich sustainability factors can be
integrated into investment decisions
differ widely and there is a variety ofways of describing them (‘sustainable
investment’, ‘ESG’, ‘responsible
investment’, etc). They also havedifferent outcomes. It is unlikely thatmany of the investors covered bysurveys and research are aware of these
distinctions or their significance, making
it potentially challenging to understandwhat they wanted in practical terms.292• Even where two or more studies use thesame sustainability-related expression,
the way it is described or explained may
nonetheless vary. As discussed in Section
1, ‘sustainability’ is a broad concept,
so individuals may vary as to exactly
what they understand by the language
used.293 It is sometimes not clear whether
survey participants were provided withdefinitions. The interpretation of key
terms may have been left largely to theindividuals concerned, again affecting thereliability of outcomes and comparability.
For these reasons, the terms used inthis section when describing particularsurveys reflect those used in thereferenced source and should not be

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

63

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understood as referencing expressions
defined elsewhere in this report.

EXECUTIVE SUMMARY• Similarly, given differences of financial

literacy, it is unlikely that all survey
participants fully understood the financial
implications of different options.
• Survey methodologies and scope reflect

the research interest or goals of therelevant actor. Surveys undertaken bycommercial organisations are likely
to have been intended to assist withbusiness development, for example, toestablish a firm’s profile in a given area.

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?

• Most of the studies focus on specificjurisdictions, especially the US, UK
and EU member states. Asia, Africa
and South America have been largely
neglected by researchers.294 However,there are several global studies byfinance firms covering a broad range
of jurisdictions, some of which also
highlight relevant differences.295

Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

64

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION
1

Influence might be brought to bear directly on enterprises orpolicymakers or indirectly through engagement with third parties,
such as scientific bodies, which can influence enterprises andpolicymakers.

2

Recognising that significant portion of many institutional investors’
assets is allocated to sovereign bonds and assets such as real estate.

3

Among others, investing that integrates ESG issues into investment
practice has been a focus for PRI and UNEP FI work culminatingin their Fiduciary Duty in the 21st Century project from 2016-2019,available at: https://www.unepfi.org/fiduciary-duty/.

4

Based on the definitions in the Oxford English Dictionary.

5

In addition to those discussed below, the word ‘sustainable’ is also
sometimes used in relation to investing and finance in ways more
focused on the investment and financial activities themselves inthe sense of whether those activities will endure over time and arein some way defensible. These uses may be connected with themeaning of sustainability discussed here, but are distinct. Wherethat distinction is not recognised it can introduce further ambiguity
into the discussion.

6

7

8

9

See the preamble of the A/RES/70/1 - Transforming our world: the2030 Agenda for Sustainable Development, available at, https://sustainabledevelopment.un.org/post2015/transformingourworld.
See also UNEP FI Positive Impact Manifesto in, Positive Impact
Finance – A Common Vision for the Financing of the Sustainable
Development Goals (SDGs), UNEP FI, available at: https://www.
unepfi.org/wordpress/wp-content/uploads/2017/06/POSITIVEIMPACT-MANIFESTO-JUNE-17.pdf, 2, (accessed 13 July 2021).
However, international law has sometimes been used as the basis forcourt decisions in some jurisdictions in a way that can be describedas having ‘direct effect’, especially in the area of human rights. See
André Nollkaemper, The Duality of Direct Effect of InternationalLaw, The European Journal of International Law, 2014, Vol 25(1), 105125.
Report of the World Commission on Environment andDevelopment: Our Common Future (the Brundtland Report), 41.
The report concludes that sustainable development, in essence,‘is a process of change in which the exploitation of resources,
the direction of investments, the orientation of technologicaldevelopment; and institutional change are all in harmony andenhance both current and future potential to meet human needs
and aspirations’, see 43. For related commentary on the historicaldevelopment of the notion of sustainability, see Andrew Basiago,
Methods of Defining ‘Sustainability’, Sustainable Development,
1995, Vol. 3(3), 109-119.
Including, notably, the 1992 Rio Declaration on Environment andDevelopment, the 2000 Millennium Development Goals, and otherkey outcomes from UN conferences and summits, as outlined in A/
RES/70/1, clauses 10-12.

10

https://sdgs.un.org/goals

11

The Paris Agreement, available at: https://unfccc.int/process-andmeetings/the-paris-agreement/the-paris-agreement.

12OECD Guidelines for Multinational Enterprises, 11th edn, OECD
Publishing, 2011. See also Responsible Business Conduct and theSDGs, OECD, 2, available at: https://mneguidelines.oecd.org/RBCand-the-sustainable-development-goals.pdf, accessed 9 February
2021.

13

The Ten Principles of the UN Global Compact, available at: https://www.unglobalcompact.org/what-is-gc/mission/principles, accessed 9
February 2021.
14

15

16

17

18

19

Guiding Principles on Business and Human Rights: Implementing
the United Nations ‘Protect, Respect and Remedy’ Framework,
developed between 2005 and 2011, endorsed by the UN Human
Rights Council in 2011, available at: https://www.unglobalcompact.
org/library/2 and https://www.business-humanrights.org/sites/
default/files/media/documents/un-human-rights-council-resolutionre-human-rights-transnational-corps-eng-6-jul-2011.pdf. The UN
Guiding Principles incorporate, by reference, key international
human rights instruments, namely: the International Bill of Rights(the Universal Declaration on Human Rights, the International
Covenant on Civil and Political Rights, and the International
Covenant on Economic, Social and Cultural Rights); the principles inthe eight International Labour Organization (ILO) core conventions as
set out in the ILO Declaration on Fundamental Principles and Rights
at Work; and, where relevant, rights relating to specific groups or
populations that may be at heightened risk of becoming vulnerable
or marginalised.
We recognise that what we are calling ultimate ends IFSI could also
be pursued instrumentally, for example, to enhance reputation.
However, we have used the expression to distinguish it clearly
from activities that are financially instrumental and to reflect themore specific focus on achieving sustainability objectives in theway activities within the scope of ultimate ends IFSI tend to be
described.
This ambiguity among investors is implicit, for example, in Max M.
Schanzenbach and Robert H. Sitkoff, Reconciling Fiduciary Dutyand Social Conscience: The Law and Economics of ESG Investingby a Trustee, Stanford Law Review, 2020, Vol. 72, 381-454.
Zvi Bodie, Alex Kane and Alan J. Marcus, Investments, 12th edn(McGraw-Hill Education 2021), G-13, use the expression ‘systematicrisk’ distinguishing it from ‘systemic risk’ (the risk of a breakdown in
the financial system, especially due to a malfunction in one part ofthe system adversely affecting other parts of the system).
Enhancing banks’ and insurers’ approaches to managing thefinancial risks from climate change, Supervisory Statement SS3/19,
Bank of England Prudential Regulation Authority, April 2019.
There are other ways of exerting an influence, for example, throughhow investors engage with counterparties and beneficiaries or
non-governmental standard-setters and, for pension funds, theircorporate sponsor. However, the project has focused on investment,
stewardship and policy engagement as the core means available
in order to establish the basic legal framework for investment
approaches within the scope of IFSI.

20

Albert Hirschman, Exit, Voice and Loyalty: Responses to Decline inFirms, Organizations and States (Harvard University Press 1970).

21

From Ideas to Practice, Pilots to Strategy: Practical Solutions andActionable Insights on How to Do Impact Investing, A report by theWorld Economic Forum Investors Industries, December 2013.

22

Joseph A. McCahery, Zacharias Sautner and Laura T. Starks, Behind
the Scenes: The Corporate Governance Preferences of Institutional
Investors, Journal of Finance, 2016, Vol. 71(6), 2905-2932.

23

Julian F. Kölbel, Florian Heeb, Falko Paetzold and Timo Busch, Can
Sustainable Investing Save the World: Reviewing the Mechanisms
of Investor Impact, Organization and Environment, 2020, Vol. 33(4),554-574.

24

ACKNOWLEDGEMENTS

See for example, Eleonora Broccardo, Oliver Hart and Luigi Zingales,
Exit vs. Voice, Working Paper, Revised, December 2020, available
at https://scholar.harvard.edu/files/hart/files/exit_vs_voice_1230.pdf,
accessed 10 July 2021; Dirk Schoenmaker and Willem Schramade,Principles of Sustainable Finance (Oxford University Press 2019), 21;
Creating Impact: The Promise of Impact Investing, IFC, 2019, 8-9.

25

Creating Impact: The Promise of Impact Investing, IFC, 2019, 14.

26This is particularly the case where the investor carries a high levelof social capital. See, for example, Chris Flood, ‘Oxford University
partners with BlackRock on sustainable investment fund’, Financial
Times, 10 November 2020.

27

Indices themselves are measurement mechanisms, not capital
allocation mechanisms. However, they can be used as a wayof allocating capital, which is the basis of passive investment
management. See Part B.4. While tracking an ESG index may notitself fall within the IFSI net, it could nonetheless form part of abroader approach to the use of the investor’s powers that does. It
could also foster outcomes similar to those covered by the concept
of IFSI.

28

See for example, Lyubov Pronina and Tom Freke, ‘As green bonds
boom, so do ‘greenwashing’ worries’, Bloomberg, 14 October 2019.

29

Gillian Tett, ‘Olive is the new green in fighting climate change’,
Financial Times, 28 January 2021; Gaia Balp and Giovanni
Strampelli, Institutional Investor Collective Engagements: NonActivist Cooperation vs Activist Wolf Packs, Ohio State Business Law
Journal, 2020, Vol. 14, 135.

30

McCahery, Sautner and Starks, Behind the Scenes: The Corporate
Governance Preferences of Institutional Investors. In some contexts,
such as private equity investment, an investor may even have a rightto appoint a member of the governing body so that they are more
directly involved in management decisions.

31

See, for example, John C. Coates, IV, The Future of Corporate
Governance Part I: The Problem of Twelve, Harvard Public Law
Working Paper No. 19-07, available at SSRN: https://ssrn.com/
abstract=3247337.

32

Recognising, however, that the impact of stewardship activity will
depend upon various factors, such as the holding structure ofbusiness enterprises in the jurisdiction concerned. See, for example,
Dan W. Puchniak, The False Hope of Stewardship in the Context
of Controlling Shareholders: Making Sense Out of the Global
Transplant of a Legal Misfit, ECGI Law Working Paper No 589/2021,
June 2021.

33

In the case of equity investment, see The Kay Review of UK Equity
Markets and Long-Term Decision Making, Interim Report, February
2012 and Final Report, July 2012 (available at https://assets.
publishing.service.gov.uk/government/uploads/system/uploads/
attachment_data/file/31544/12-631-kay-review-of-equity-marketsinterim-report.pdf, 10, 22 et seq.

34

That said, where stewardship results in changes in the sustainability
exposure or impact of an enterprise, that may in turn influence
investors’ investment decisions; in this way, stewardship focused onsustainability impacts might be expected to increase the numberof enterprises in which an investor applying certain sustainability
parameters is prepared to invest.

35

However, it is possible that stewardship in this context could be
more effective when combined with some passive investment
strategies, such as those using forms of sustainability-based

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

65

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION
screening, as compared with others.
36

A Matter of Purpose, Larry Fink’s 2018 Letter to CEOs, (available athttps://www.blackrock.com/corporate/investor-relations/2018-larryfink-ceo-letter, accessed 29 January 2021).

37

Schoenmaker and Schamrade, Principles of Sustainable Finance,
21, 89.

38

Balp and Strampelli, Institutional Investor Collective Engagements:
Non-Activist Cooperation vs Activist Wolf Packs,; Lucian A. Bebchuk,
Alma Cohen and Scott Hirst, The Agency Problems of Institutional
Investors, Journal of Economic Perspectives, 2017, Vol. 31, 89-102.

39

See, for example, Jennifer Thompson, ‘Pension funds raise concern
over index manager stewardship’, Financial Times, 23 June 2019.

40

For example, in its 2019 Active Ownership Report, Legal & General
Investment Management notes that it chooses to engage withinvestee companies that can set an example in their sector: Active
Ownership Report 2019, Legal & General Investment Management,
2020, 50.

41

Elroy Dimson, Oğuzhan KarakaşXi Li, Coordinated Engagements,
ECGI Finance Working Paper No. 721/2021, January 2021; Balp andStrampelli, Institutional Investor Collective Engagements: NonActivist Cooperation vs Activist Wolf Packs.

42

Examples include Climate Action 100+ (see https://climateaction100.wpcomstaging.com) and the Dutch Pension
Funds Agreement on Responsible Investment to which morethan 80 pension funds have now committed (available at https://www.imvoconvenanten.nl/en/pension-funds/convenant/-/
media/6B9D0FF0577E44F29DBF2EDB58767AAE.ashx, accessed 24
September 2020). See also Schoenmaker and Schamrade, Principles
of Sustainable Finance, 106 et seq.

43

See, for example, Building a Regulatory Framework for Effective
Stewardship: Feedback to DP 19/1, Financial Conduct Authority,
Feedback Statement 19/7, October 2019, paragraphs 3.34-3.36.

44

See Taking Stock: Sustainable Finance Policy Engagement andPolicy Influence, PRI, 2019.

45

Policy Frameworks for Long-term Responsible Investment: The
Case for Investor Engagement in Public Policy, PRI, November
2014.

46

https://thegiin.org

47

https://impactmanagementproject.com

48

https://www.impactprinciples.org

49

https://www.weforum.org/platforms/shaping-the-future-of-investing50

https://www.oecd.org/dac/financing-sustainable-development/
development-finance-topics/social-impact-investment-initiative.htm

51

https://gsgii.org

52

https://www.unepfi.org/positive-impact/positive-impact/53

We have undertaken a high-level review for the purposes of thisReport.

54

Impact investors may be more likely to pursue ultimate ends IFSI
than other categories of investor, but their activities could include
both instrumental and ultimate ends IFSI.

55

Alternatively, some impact investors may treat not losing the capital
invested as a base line. That would not be usual for the type of asset
owners covered by this project.

56

57

58

See, for example, From the Margins to the Mainstream: Assessmentof the Impact Investment Sector and Opportunities to Engage
Mainstream Investors, A Report by the World Economic Forum
Investors Industries, World Economic Forum, 2013, particularly
sections 1 and 3; Social Impact Investment: Building the
Evidence Base, OECD, 2015, 26 et seq. See also the profile of thoseparticipating in the GIIN Annual Impact Survey, 2020: Annual
Impact Investor Survey 2020, Global Impact Investing Network,
2020, 1, 25 and 69 et seq.
Social Impact Investment: Building the Evidence Base, OECD, 2015,16. See also the discussion of the impact investing ‘demand-side’
at 24 et seq. which talks variously of ‘social enterprises’ and ‘social
ventures’, but does not consider the relationship between investingin this sort of enterprise and capital allocation to companies meetingsocial needs more widely, such as utilities companies.
See, for example, World Economic Forum, From the Margins to
the Mainstream, 9, 15 et seq.; Social Impact Investment: Building
the Evidence Base, OECD, 2015, 46 et seq.; Creating Impact: The
Promise of Impact Investing, IFC, 2019, 2; and examples of impact
investments given in Social Impact Investment 2019: The Impact
Imperative for Sustainable Development, OECD, 2019. A desire
to look beyond this traditional focus lies behind the PRI’s Impact
Investing Market Map, PRI, 2018. The GIIN Annual Impact Investor
Survey 2020, 38 et seq. indicates that the largest share of the AuMof those surveyed (65 per cent) was invested in mature public or
private companies. That was out of an aggregate amount of $400bn(objectively large, but modest by reference to global AuM, see PartA.3), and the nature of the enterprises to which the capital was
allocated (as opposed to the company from which the enterprise
was being run) is unclear. However, GIIN’s figures nonethelesssuggest that allocation to more mature companies by impact
investors has been growing since 2015.

59

Descriptions based on What is Responsible Investment?, PRI, and
PRI Reporting Framework: Main definitions, PRI, November 2018.

60

See, for example, Quinn Curtis, Jill E. Fisch and Adriana Z. Robinson,
Do Mutual Funds Deliver on Their Promises, ECGI Law Working
Paper No. 586/2021, June 2021 (39 et seq.), which finds evidence ofdistinctive voting in relation to ESG factors among some US mutual
funds suggesting that the funds concerned are seeking to influence
corporate behaviour.

61

There has been little work to date on the impact of sustainable
investment generally: Kölbel, Heeb, Paetzold and Busch, Can
Sustainable Investing Save the World: Reviewing the Mechanisms
of Investor Impact.

62

See, for example, the Disclosure Regulation, which includes adefinition of ‘sustainable investment’, ‘sustainability risk’ and‘sustainability factors’, and amendments to the EU Markets in
Financial Instruments Directive which introduce concepts suchas ‘sustainability preferences’: Commission Delegated Regulation(EU) …/… of 21 April 2021 amending Delegated Regulation (EU)2017/565 as regards the integration of sustainability factors, risks andpreferences into certain organisation requirements and operating
conditions for investment firms, COM(2021) 2616.

63

See, for example, European SRI Study, EUROSIF, 2018, 9; Anna
Katharina Höchstäder and Barbara Sheck, What’s in a Name: An
Analysis of Impact Investing Understandings by Academics andPractitioners, Journal of Business Ethics, 2015, Vol. 132, 449-475;
Neil. S. Eccles and Suzette Viviers, The Origins and Meanings
of Names Describing Investment Practices that Integrate a

Consideration of ESG Issues in the Academic Literature, Journal ofBusiness Ethics, 2011, Vol. 104, 389-402; Joachim Sandberg, Carmen
Juravle, Ted M. Hedesström and Ian Hamilton, The Heterogeneityof Socially Responsible Investment, Journal of Business Ethics,
2009, Vol. 87, 519-533. See also Performing for the future: ESG’splace in investment portfolios. Today and tomorrow, State Street
Global Advisors, 2018, 17 (https://www.ssga.com/investment-topics/
environmental-social-governance/2017/esg-institutional-investorsurvey-us.PDF) which suggests that 56 per cent of institutional
investors adopting ESG-investment believe that there is a lack ofclarity over ESG terminology.
64

The State of Impact Measurement and Management Practice, 2ndedn, GIIN, 2020.

65

What are sometimes called ‘primary rules’: Hart, H. L. A., The Conceptof Law, 3rd edn (Oxford University Press 2012), especially chapters III
and V.

66

Impact Frontiers Collaboration, ‘How Investors Can Integrate Social
Impact With Financial Performance to Improve Both’, Stanford Social
Innovation Review, 15 May 2020.

67

As noted in Part A.1.4, this sort of investing is not necessarily thesame as IFSI but could be combined with IFSI strategies.

68

Gunnar Friede, Freddy Busch and Alexander Bassen, ESG and
Financial Performance: Aggregated Evidence From More Than
2000 Empirical Studies, Journal of Sustainable Finance andInvestment, 2015, Vol 5(4), 210-233. See also, Hortense Bioy, ‘Do
sustainable funds beat their rivals’, Morningstar, 16 June 2020
(https://www.morningstar.co.uk/uk/news/203214/do-sustainablefunds-beat-their-rivals.aspx, accessed 13 February 2021), reportingon a Morningstar study of 4,900 mutual funds, finding that 58.8 percent of sustainable funds that existed over a ten year period throughto 2019 out-performed their average surviving traditional peers,
although this pattern was not the same across all asset classes.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?

69

Global Financial Stability Report, International Monetary Fund,2019, 85-87.

Appendix 1

70

Gary Cundill, Palie Smart and Hugh N. Wilson, Non-financial
Shareholder Activism: A Process Model For Influencing Corporate
Environmental and Social Performance, International Journal ofManagement Reviews, 2017, Vol. 20(2), 606-626.

Appendix 2

71

Elroy Dimson, Oğuzhan Karakaşand Xi Li, CoordinatedEngagements, ECGI Finance Working Paper No. 721/2021,
January 2021; Tamas Barko, Martijn Cremers and Luc Renneboog,
Shareholder Engagement on Environmental, Social andGovernance Performance, ECGI Finance Working Paper No.
509/2017, August 2017.

Supplement to Appendix 3

72

See, for example, How ESG Engagement Creates Value forInvestors and Companies, PRI, 2018; Andreas Hoepner et al., ESG
Shareholder Engagement and Downside Risk, ECGI Working Paper
Series in Finance, Working Paper No. 671/2020.

73

By contrast, some sustainability goals are likely to fall largely outside
the influence of mainstream investors so cannot obviously be
addressed through IFSI. For example, the SDG target of providing
legal identity for all (SDG 16.9), principally requires government
action. That said, business activity is likely to have some role inachieving most sustainability goals; even in the case of providing
legal identity, solutions may be facilitated by new technologies.

74

See https://www.climateaction100.org/news/views-from-aroundthe-world-an-interview-with-andrew-gray-from-australiansuper/

Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

66

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION(accessed 6 March 2021).
75

https://www.iigcc.org/news/climate-action-100-issues-its-first-evernet-zero-company-benchmark-of-the-worlds-largest-corporateemitters/ (accessed 23 June 2021).

76

See, for example, the summary of the evolution of the TCFD’s
disclosure recommendations and guidance in Forward-looking
Financial Sector Metrics, Task Force on Climate-Related Financial
Disclosures, October 2020, 1.

(https://www.hbs.edu/impact-weighted-accounts/Pages/default.
aspx, accessed 16 February 2021), another is the PwC Total Impact
Measurement and Management Framework (https://www.pwc.
com/gx/en/services/sustainability/total-impact-measurementmanagement.html, accessed 16 February 2021).
91

https://www.unepfi.org/publications/positive-impact-publications/
corporate-impact-tool/#:~:text=The%20Corporate%20Impact%20
Analysis%20Tool,across%20different%20sectors%20and%20
countries.

92

Developed by the United Nations Global Compact, B Lab and others:
see https://www.unglobalcompact.org/take-action/sdg-actionmanager.

77

In the case of climate-related risk alone, see FSB Roadmap for
Addressing Climate-Related Financial Risks, Financial Stability
Board, 7 July 2021.

78

Annual Impact Investor Survey 2020, GIIN, 2020, 44 et seq.; IFC,
Growing Impact, 21.

9379https://eur-lex.europa.eu/legal-content/EN/
TXT/?uri=CELEX:32020R0852

See https://www.sasb.org/standards-overview/materiality-map/,
accessed 21 October 2020.

94

80

See https://www.gov.uk/government/news/chancellor-sets-outambition-for-future-of-uk-financial-services (accessed 16 February2021).

See https://www.globalreporting.org/about-gri/mission-history/,
accessed 21 October 2020.

81

Inaugural 2025 Target Setting Protocol, the UN Convened Net
Zero Asset Owner Alliance, 2021; Net Zero Investment Framework:
Implementation Guide, Institutional Investors Group on Climate
Change, March 2021.

82

Climate Action 100+ Sector Strategy: Aviation – Recommended
Expectations, Climate Action 100+, January 2021.

83

PRI, Impact Investing Market Map, 6.

84

See https://impactmanagementproject.com/impact-management/
impact-management-norms/, accessed 13 February 2021.

85

86

95

Consultation Paper on Sustainability Reporting, IFRS, September
2020 .

96

See, for example, https://www.iigcc.org/resource/investorexpectations-for-paris-aligned-accounts/ (accessed 25 November2020).

97

The bodies involved are B Lab, CDP, CDSB, GIIN, the GRI, the Global
Steering Group for Impact Investment, the IFC, IIRC, the OECD, the
PRI, SASB, Social Value International, the UNDP, the UNEP FinanceInitiative, the UN Global Compact and the World Benchmarking
Alliance.

98

Overview of the Impact Management Project, Impact Management
Project 1, available at https://29kjwb3armds2g3gi4lq2sx1-wpengine.
netdna-ssl.com/wp-content/uploads/Investor_s-Perspective_-AShared-Convention-for-Impact-Management.pdf (accessed 8
October 2020).
This was, for example, identified as an issue by the World Economic
Forum in 2013: From the Margins to the Mainstream: Assessmentof the Impact Investment Sector and Opportunities to Engage
Mainstream Investors, A report by the World Economic Forum
Investors Industries, September 2013, 26. See also Creating
Impact: The Promise of Impact Investing, IFC, 2019, 40, and,in the wider market Impact Investing Market Map, PRI, 2018,
10 and Sustainable Signals: Growth and Opportunity in AssetManagement, Morgan Stanley Institute for Sustainable Investing/
Bloomberg, 2019, 12.

87Creating Impact: The Promise of Impact Investing, IFC, 2019, 44 et
seq.

88

See, for example, Measuring Portfolio Alignment: Assessing the
Position of Companies and Portfolios on the Path to Net Zero, The
Portfolio Alignment Team, 2020 (available at https://www.tcfdhub.
org/wp-content/uploads/2020/10/PAT-Report-20201109-Final.pdf,
accessed 27 April 2021).

89

The concept of ‘total societal impact’, developed by Boston
Consulting Group appears to fall within this category. See Total
Societal Impact: A New Lens for Strategy, The Boston Consulting
Group, October 2017.

90

The Harvard Business School Impact Weighted Accounts initiative
is an attempt to do something of this sort at enterprise level

99

100

101

Statement of Intent to Work Together Towards Comprehensive
Corporate Reporting: Summary of Alignment Discussions Among
Leading Sustainability and Integrated Reporting Organizations,
CDP, CDSB, GRI, IIRC and SASB, September 2020. See also
Reporting on enterprise value illustrated with a prototype
climate-related financial disclosure standard, progress towards
a comprehensive reporting system, from leading sustainability
and integrated reporting organisations CDP, CDSB, GRI and SASB,
facilitated by the Impact Management Project, World Economic
Forum and Deloitte, December 2020.
Consultation Paper on Sustainability Reporting, IFRS, September
2020. In February 2021 the trustees confirmed that work isunderway to establish a new board that will ‘focus on informationthat is material to the decisions of investors, lenders and othercreditors.’ It is unclear whether materiality is to be understoodin exclusively financial terms. See https://www.ifrs.org/news-andevents/2021/02/trustees-announce-next-steps-in-response-to-broaddemand-for-global-sustainability-standards/, accessed 16 March
2021.
Measuring Stakeholder Capitalism: Towards Common Metrics
and Consistent Reporting of Sustainable Value Creation, World
Economic Forum White Paper, 2020, 6.
See Forward-looking Financial Metrics Consultation – Summaryof Responses, Task Force on Climate-Related Financial Disclosures,
March 2021.

102

APG, AustralianSuper, British Columbia Investment Management
Corporation and PGGM. See https://www.pggm.nl/en/press/us-1trillion-asset-owner-platform-launches-solution-for-identifying-sdginvestments/, accessed 13 October 2020.

103

https://www.fsb-tcfd.org/

104

In relation to the EU, see for example, https://eur-lex.europa.eu/legalcontent/EN/TXT/?uri=CELEX:52019XC0620(01).

105

https://corporatereportingdialogue.com/better-alignment-project/

106

Article 19a(1) of Directive 2013/34/EU (introduced by the NonFinancial Reporting Directive).

107

Guidelines on non-financial reporting: Supplement on reporting
climate-related information, Communication from the Commission(2019/C-209/01), at 2.2.

108

Florian Berg, and Julian Kölbel and Roberto Rigobon, Aggregate
Confusion: The Divergence of ESG Ratings (May 17, 2020), available
at https://ssrn.com/abstract=3438533; Florian Berg, Kornelia Fabisik,
and Zacharias Sautner, Rewriting History II: The (Un) predictable
Past of ESG Ratings, ECGI Finance Working Paper N° 708/2020,
November 2020. This has provided an impetus for new entrants,
such as Arabesque.

109

110

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

The complex interactions between different reporting frameworks
is well illustrated in a matrix prepared by the Carbon DisclosureStandards Board which only covers disclosure in those area of
business that are the particular concern of the CDSB, available
at https://www.cdsb.net/sites/default/files/making_the_connections_2018.pdf (accessed 21 October 2020).

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

See https://www.sasb.org/wp-content/uploads/2016/12/StdsDevInDepth-22Sept2016_generalized_336.pdf, accessed 21 October
2020.

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?

111

See https://www.global-value.eu/navigator.php.

112

Impact Investing Market Map, PRI, 2018.

113

https://iris.thegiin.org/metrics/.

114

Measuring Stakeholder Capitalism, World Economic Forum.

115

A set of impact management tools and measures, developed by
GIIN and based on the earlier IRIS Catalog, which includes core
metrics sets for use in impact measurement.

116

Annual Impact Investor Survey 2020, GIIN, 2020, 46.

117

Creating Impact: The Promise of Impact Investing, IFC 2019, 3, 5;Paul Brest, Ronald J. Gilson and Mark A. Wolfson, How Investors Can(And Can’t) Create Social Value, Journal of Corporation Law, 2019,Vol. 44, 205-231.

118

From the Margins to the Mainstream: Assessment of the Impact
Investment Sector and Opportunities to Engage Mainstream
Investors, A report by the World Economic Forum Investors
Industries, September 2013, 26.

119

See, for example, Wendy Abt, ‘Almost Everything You Know About
Impact Investing is Wrong’, Stanford Social Review, 18 December
2018.

120

Creating Impact: The Promise of Impact Investing, IFC 2019, 3.

121

Investor Contribution in Public and Private Markets, Discussion
Document, Impact Management Project, January 2019.

122

Growing Impact: New Insights into the Practice of Impact
Investing, IFC, June 2020.

123

See, for example, the IMP’s discussion of ‘contribution’ at, https://
impactmanagementproject.com/impact-management/impactmanagement-norms/contribution/, accessed 19 March 2021.

124

Wendy Abt, ‘Almost Everything You Know About Impact Investing isWrong’.

Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

67

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION
125

Patrick Carter, Nicolas Van de Sijpe and Raphael Calel, The Elusive
Quest for Additionality, Center for Global Development, Working
Paper 495, September 2018.

126

Brest, Gilson and Wolfson, How Investors Can (And Can’t) Create
Social Value.

127

BCG Global Asset Management 2020 – Protect, Adapt andInnovate, 5 f. This study comprises assets that are managed against
compensation (ie management fees) by professionals, including
captive AuM for insurance groups.

html; https://www.morningstar.com/articles/961935/2019-fundflows-in-9-charts (both accessed 18 September 2020). See also The
World’s Largest 500 Asset Managers 2020, Willis Towers Watson, 9,
which suggests that passive investments increased by 25.3 per centduring 2019.
146

BCG Global Asset Management 2020 – Protect, Adapt andInnovate, 6.

147

AuM in Europe in 2019 increased by 13per cent from $20.2tn to$22.8tn (BCG Global Asset Management 2020 – Protect, Adapt andInnovate, 6).

128

The World’s Largest 500 Asset Managers 2020, Thinking Ahead
Institute, Willis Towers Watson, October 2020, 8.

148

129

PRI Annual Report, available at https://www.unpri.org/annualreport-2020

BCG Global Asset Management 2020 – Protect, Adapt andInnovate, 7.

149

Ibid, 7.

130

Asset and Wealth Management Revolution: The Power to Shapethe Future, PwC, 2020, 2.

150

Ibid, 7.

1312020 Market Highlights, World Federation of Exchanges, available
at https://www.world-exchanges.org/storage/app/media/FH.FY%20
2020%20Market%20Highlights%20v8.pdf (accessed 29 March 2020).

151

The World’s Largest 500 Asset Managers 2019, Willis Towers Watson,
11.

152

Ibid, 18.

153

Data for Japan as of 31 March 2018.

154

GSIA, Global Sustainable Investment Review 2018, 8. The GSIA iscurrently working on an updated review, but it was not available atthe time of going to print.

155

2020 Report on US Sustainable and Impact Investing Trends, US
SIF, 2020.

156

Sustainable Investment in the European Asset Management
Industry: Defining and Sizing ESG Strategies, European Fund andAsset Management Association, Market Insights, Issue 3, November
2020. Jurisdictions covered included the UK and Switzerland.

132

BIS Quarterly Review: International Banking and Financial Market
Developments, Bank of International Settlements, September 2020,
A11.

133

Global Pension Fund Assets Study, Thinking Ahead Institute, Willis
Towers Watson, 2021, 6.

1342021 Investment Company Fact Book: A Review of Trends andActivities in the Investment Company Industry, Investment
Company Institute, 61st edn, 2021, 7.

135

Global Monitoring Report on Non-Bank Financial Intermediation,
Financial Stability Board, 2020, 13.

136

The World’s Largest 500 Asset Managers 2020, The Thinking Ahead
Institute, 44 et seq.

137

Ibid, 9.

138

See, for example, The World’s Largest 500 Asset Managers 2020,
Willis Towers Watson.

139

Blackrock, $8.15tn (unaudited) as at 31 December 2020 (https://s24.q4cdn.com/856567660/files/doc_financials/2020/Q4/BLK-4Q20Earnings-Release.pdf, 5, accessed 30 March 2021); Vanguard, passed$7tn AuM during 2020 (Chris Flood, ‘Vanguard’s assets hit $7tn’,
Financial Times, 13 January 2021); State Street Global Advisors,$3.4tn as at 31 December 2020 (https://www.ssga.com/us/en/
institutional/ic/about-us/who-we-are, accessed 30 March 2021).

157

Sustainability Goes Mainstream: 2020 Global Sustainable Investing
Survey, BlackRock, 2020. Covered a total of 425 corporate and public
pension funds, sovereign wealth funds, insurers, asset managers,
endowments, foundations and global wealth managers from 27
countries with a particular concentration in EMEA.

158

Asset and Wealth Management Revolution: The Power to Shapethe Future, PwC, 2020, 10.

159

ChinaSIF, China Sustainable Investment Review 2019, 6. See also,
Eric Ng, ‘China begins to embrace global sustainable investment
trend, but big names still missing says China-chief of UN-backed
body’, South China Morning Post, 17 February 2019; Chad Bray andLouise Moon, ‘Asia behind in sustainable investing, but attitudes
are changing, industry leaders say’, South China Morning Post, 18
October 2019.

140

David MacLaughlin and Annie Massa, ‘The Hidden Dangers of theGreat Index Fund Takeover’, Bloomberg, 9 January 2020.

160

ChinaSIF, China Sustainable Investment Review 2019, 6.

141

BCG, Global Asset Management 2020, Protect, Adapt, andInnovate, 9.

161Categories and descriptions taken from GSIA, Global Sustainable
Investment Review, 7.

142

The World’s Largest 500 Asset Managers 2020, Willis Towers
Watson, 37, suggests a lower figure but this may have been the resultof a smaller sample size.

162

143

Robin Wigglesworth and Alex Janiaud, ‘Index funds break through$10tn-in-assets mark amid active exodus’, Financial Times, 8January 2020.

Growing Impact: New Insights into the Practice of Impact
Investing, IFC, 2020, 11. For evidence that some US mutual fundswith ESG objectives do engage in distinctive ESG voting patterns, see
Quinn Curtis, Jill E. Fisch and Adriana Z. Robinson, Do ESG Mutual
Funds Deliver on Their Promises? ECGI Law Working Paper No.
586/2021, June 2021, 39 et seq.

144

The World’s Largest 500 Asset Managers 2019, The Thinking Ahead
Institute, Willis Towers Watson, 32.

163

GSIA, Global Sustainable Investment Review 2018, 10.

164

145

https://www.morningstar.com/blog/2019/01/28/us-fund-flows-trends.

Social Impact Investment: Building the Evidence Base, OECD,
2015,11 highlights the limited available data on social impact

ACKNOWLEDGEMENTS

investing.
165

Social Impact Investment 2019: The Impact Imperative For
Sustainable Development, OECD 2019, 223.

166

GIIN, Annual Impact Investor Survey 2020, XIII.

167

GIIN, Annual Impact Investor Survey 2020, 40.

168

IFC, Growing Impact, 13.

169

Impact Investment Market Map, PRI, 2018, 8.

170

IFC, Growing Impact, 13.

171

See, for example, Creating Impact: The Promise of Impact Investing,
IFC, 2019, 20; Special Report: Institutional Investors U.S. Results,
Edelman Trust Barometer 2020, Edelman, 2020.

172

https://www.netzeroassetmanagers.org/ and https://www.unepfi.org/
net-zero-alliance/ (both accessed 10 July 2021).

173

https://www.climateaction100.org/ (accessed 17 June 2021).

174

A more detailed summary of the studies and surveys consideredis available at SSRN: https://ssrn.com/abstract=3888570. For
studies published in the period before 2017, see the literature
review prepared by the Cambridge Institute of Sustainability
Leadership during 2018 (available from the Institute) in connection
with Walking the Talk: Understanding Consumer Demand for
Sustainable Investing, a study by the Cambridge Institute for
Sustainability Leadership, October 2019. Its findings were similar
to those reported below, but more recent work (including theInstitute’s own study, described in Walking the Talk) provides
valuable new insights.

175

Walking the Talk, Cambridge Institute for Sustainability Leadership,
8.

176

See, for example, Steve Schueth, Socially Responsible Investing in
the United States, Journal of Business Ethics, 2003, Vol. 43, 189-194,
189; Céline Louche, Daniel Arenas and Katinka C. van Cranenburgh,
From Preaching to Investing: Attitudes of Religious Organisations
Towards Responsible Investment, Journal of Business Ethics, 2012,
Vol. 110, 301-320, 302; and Kölbel, Heeb, Paetzold and Busch, Can
Sustainable Investing Save the World: Reviewing the Mechanisms
of Investor Impact.

177

Louche, Arenas, and van Cranenburgh, From Preaching to Investing:Attitudes of Religious Organisations Towards Responsible
Investment, 303. One of the earliest funds combining an emphasison environmental, social and governance matters combined withfinancial return was launched in Norway in 1995 (a joint initiativeof Storebrand Asset Management and Scudder, Stevens & Clark),
based on an eco-efficiency concept of the World Business Council
for Sustainable Development: see Claudia H. Deutcsh, ‘Investing it;
for Wall Street, Increasing Evidence that Green Begets Green’, NewYork Times, 19 July 1998. Sarasin Bank launched a similar fund thefollowing year.

178

See The Materiality of Social, Environmental and Corporate
Governance Issues to Equity Pricing: 11 Sector Studies by Brokerage
House Analysts at the Request of the UNEP Finance Initiative
Asset Management Working Group, UN Environment Programme
Finance Initiative (2004).

179

The Global Compact, Who Cares Wins – Connecting Financial
Markets to a Changing World, June 2004, i, available at: https://www.ifc.org/wps/wcm/connect/de954acc-504f-4140-91dcd46cf063b1ec/WhoCaresWins_2004.pdf?MOD=AJPERES&CACHEID=EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

68

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTIONROOTWORKSPACE-de954acc-504f-4140-91dc-d46cf063b1ec-jqeE.
mD.
180

A legal framework for the integration of environmental, socialand governance issues into institutional investment, Freshfields
Bruckhaus Deringer LLP 2005, https://www.unepfi.org/fileadmin/
documents/freshfields_legal_resp_20051123.pdf

181

Reflected, for example, in the growing membership of the PRI. See
also GSIA, 2018 Global Sustainable Investment Review and Bailard
Wealth Management, From SRI to ESG: The Origins of Socially
Responsible and Sustainable Investing, June 2017, available at:https://www.bailard.com/wp-content/uploads/2017/06/SociallyResponsible-Investing-History-Bailard-White-Paper-FNL.pdf?pdf=SRIInvesting-History-White-Paper.

182

183

184

Final Report of the Strategic Assessment of the Rockefeller
Foundation’s Impact Investing Initiative, E.T. Jackson and Associates
Ltd, 2012, 40, available at: https://www.rockefellerfoundation.org/wpcontent/uploads/Impact-Investing-Evaluation-Report-20121.pdf. The
Foundation has invested over $40m to develop impact investing as afield (see Jem Hudson, ‘The State of Impact Investing’, The Wharton
Magazine, 26 June 2014, available at https://magazine.wharton.
upenn.edu/digital/the-state-of-impact-investing/, accessed 12 March
2021).

Joachim Sandberg, Carmen Juravle, Ted M. Hedesström and Ian
Hamilton, The Heterogeneity of Socially Responsible Investment,
Journal of Business Ethics, 2009, Vol. 87, 519-533, 524; Grant
Michelson, Nick Wailes, Sandra Van Der Laan and Geoff Frost, EthicalInvestment, Processes and Outcomes, Journal of Business Ethics,
2004, Vol. 52, 1–10, 1.

193

https://www.unpri.org/pri/an-introduction-to-responsible-investment/
what-is-responsible-investment.

194

Global Sustainable Investment Review 2016, Global Sustainable
Investment Alliance (GSIA), 26, available at: http://www.gsi-alliance.
org/wp-content/uploads/2017/03/GSIR_Review2016.F.pdf.

195

https://www.robeco.com/de/unsere-expertise/sustainable-investing/glossary/socially-responsible-investing.html.

208

See for example, ‘Advisers predict more ESG investing in the wake of
Covid-19’, Standard Life, 1 December 2020, available at https://www.
standardlife.co.uk/about/press-releases/advisers-predict-more-esginvesting-in-the-wake-of-covid19 (accessed 12 April 2021); ‘Interest
in ESG investing boosted by Covid’, Aviva, 29 October 2020, available
at https://www.aviva.com/newsroom/news-releases/2020/10/interestin-esg-investing-boosted-by-covid/ (accessed 12 April 2021). This isalso reflected in changing institutional investor attitudes: see, forexample, Survey Analysis: ESG Investing Pre- and Post-Pandemic,
Institutional Investor Services, Inc, 2020. See also Ola Mahmoud
and Julia Meyer, Social Responsibility in the Time of Uncertainty: A
Natural Experiment, 28 January 2021, available at SSRN: https://ssrn.
com/abstract=3774995.
In the case of US investors, see for example Sustainable Signals:
New Data from the Individual Investor, Morgan Stanley Institutefor Sustainable Investing, 2017; Walking the Talk, The Cambridge
Institute for Sustainability Leadership, 7; Insights on Wealth andWorth, US Trust, 2018 (available at https://scholarworks.iupui.edu/
bitstream/handle/1805/17666/high-net-worth2018-summary.pdf,
accessed 13 April 2021); Fourth Annual Responsible Investing
Survey, Nuveen, 2018. However, the findings of surveys are notconsistent on this: see for example Global Investor Study. Are People
Compelled to Invest Sustainably?, Schroders, 2019, 5.

EU Commission, Impact Assessment, SWD (2018) 264 final, 146.

197

Global Sustainable Investment Review 2018, Global Sustainable
Investment Alliance (GSIA), 7.

198

There are a few exceptions. See, for example, Clean Slate, Green
Slate: Public and Investor Attitudes to ‘Good’ Money 2020, UK
Sustainable Investment and Finance Association, 2020, 6.

As noted in Section A, the concept of investing for sustainability
impact used in this report is intended to catch a broader range ofactivities than those commonly thought of as impact investing, butwould include impact investing.

199

Investing in a Better World: Understanding the UK Public’s
Demand for Opportunities to Invest in the Sustainable
Development Goals, UK Department for International Development,
Investing in a Better World Project, 2019, 7, 20.

209

The French and SRI, run by Ipsos for Vigeo Eiris and the FIR,
September 2017.

See, for example, From the Margins to the Mainstream: Assessmentof the Impact Investment Sector and Opportunities to Engage
Mainstream Investors, a report of the World Economic Forum
Investors Industries prepared in collaboration with Deloitte Touche
Tohmatsu, September 2013; Social Impact Investment 2019: The
Social Impact Imperative for Sustainable Development, OECD
2019; Annual Impact Investor Survey 2020, 10th edn, Global Impact
Investing Network, 2020

200

Sustainable Signals: Individual Investor Interest Driven by Impact,
Conviction and Choice, Morgan Stanley Institute for Sustainable
Investing, September 2019, 1. The level of interest among US
investors with this level of investible assets was similar in the Nuveen
Fifth Annual Responsible Investing Survey, Nuveen, 2019. See
also Retirement Reality Check: A Generational Look at DefinedContribution Plan Participation, Natixis 2019.

210

Trust, Transparency and the Quest for Clarity, Natixis Investment
Managers, 2017, 6 (covering 8,300 individuals with a minimum of$100,000 in investable assets).

211

Global Investor Study, Schroders, 2019, 5. Note, however, that thesurvey asked participants to rank the importance of three sorts ofsustainable investing which did not obviously include approaches
that would fall within the definition of IFSI, 13.

212

Sustainable Signals, Morgan Stanley Institute for Sustainable
Investing, September 2019, 2.

213

Retirement Reality Check, Natixis 2019, 7.

214

SII Attitudinal and Behavioural Research, Greg B Davies andCentapse, 2017, 14.

.

Social Impact Investment: Building the Evidence Base, OECD, 2015,
10.

186

OECD, Social Impact Investment 2019 (see especially Chapter 4);
GIIN, Annual Impact Investor Survey 2020; Growing Impact: New
Insights into the Practice of Impact Investing, IFC, 2020.

187

See https://www.gov.uk/government/news/social-impact-investmentforum, accessed 12 September 2020; OECD, Social Impact
Investment 2019, 163-164.

188

See World Economic Forum Investors Industries, From the Margins
to the Mainstream; From Ideas to Practice, Pilots to Strategy:
Practical Solutions and Actionable Insights on How to Do Impact
Investing, a report by the World Economic Forum Investors
Industries, December 2013.
See for example, Michael Porter and Mark Kramer, Creating Shared
Value – How to reinvent capitalism – and unleash a wave ofinnovation and growth, Harvard Business Review, January-February
2011, 1-17, 15.

190

See, for example, Capital as a Force for Good: Global FinanceIndustry Leaders Transforming Capitalism for a Sustainable Future(Force for Good 2020).

191

EUROSIF, European SRI Study 2012, 10, available at: http://www.
eurosif.org/wp-content/uploads/2014/05/eurosif-sri-study_low-resv1.1.pdf; OECD, Investment governance and the integration of201

Ethics and Investing: How Environmental, Social and Governance
Issues Impact Investor Behavior, Allianz Life Insurance Company ofNorth America 2019.

202

Lei Delsen and Alex Lehr, Value Matters or Values Matter?
An Analysis of Heterogeneity in Preferences for Sustainable
Investment, Journal of Sustainable Finance and Investment, 2019,Vol. 9(3) 240-261. See also Rob Bauer, Tobias Ruof and Paul Smeets,
Get Real! Individuals Prefer More Sustainable Investments,
February 2021, available at SSRN: https://ssrn.com/abstract=3287430.

203

The French and SRI: Results of the 8th National Survey run by Ipsos
for Vigeo Eiris and the FIR, September 2017, press release available
at https://vigeo-eiris.com/wp-content/uploads/2017/09/20170921_
CP_GC_Les-Français_et_lISR-ENG-1.pdf, accessed 12 April 2021.

204

A Large Majority of Retail Clients Want to Invest Sustainably:
Survey of French and German Retail Investors’ Sustainability
Objectives, 2˚ Investing Initiative, March 2020.

205

Growing consumer demand for ethical investing: 4 in 5 Australians
prepared to switch funds, Responsible Investment Association
Australasia, press release, November 2017, available at https://
responsibleinvestment.org/wp-content/uploads/2017/11/Mediarelease-Growing-consumer-demand-for-ethical-investing-15-Nov.pdf(accessed 25 April 2021).

206

Global Investor Study - Under Pressure: Investors’ Response to
Crisis, Schroders, 2020; Looking for the Best of Both Worlds, Natixis

ACKNOWLEDGEMENTS

Investment Managers, 2019.
207

196

185

189

environmental, social and governance factors, 2017, 7.
192

215

Consumer Survey, AXA Investment Managers UK, 2018, 19.

216

Annual Triodos Bank Impact Investing survey: Socially Responsible
Investing market on the cusp of momentous growth, press release
5 September 2018 (https://www.triodos.co.uk/press-releases/2018/socially-responsible-investing-market-on-cusp-of-momentus-growth,accessed 13 April 2021).

217

Anett Wins and Bernard Zwergel, Comparing Those Who Do, Might
and Will Not Invest in Sustainable Funds: A Survey Among German
Retail Fund Investors, Business Research, 2016, Vol. 9, 51-99.

218

Joakim Sandberg and Jonas Nilsson, Do Ethical Investors Want
Purity or Effectiveness? An Exploratory Study on the EthicalPreferences of Mutual Fund Investors, Journal of Financial Services
Marketing, 2015, Vol. 20, 34-45, 40.

219

A Large Majority of Retail Clients Want to Invest Sustainably, 2˚Investing Initiative, March 2020, 30.

220

Ibid. 9.

221

Brodback, Guenster and Mezger, Altruism and Egoism in

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

69

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION
Investment Decisions, Review of Financial Economics, 2019, Vol.
37(1), 118-148.
222

Investing in a Better World, UK Department for International
Development, 7.

223

Fourth Annual Responsible Investing Survey, Nuveen, 2018.

224

Bauer, Ruof and Smeets, Get Real! Individuals Prefer More
Sustainable Investments, 5.

225

Fifth Annual Responsible Investing Survey, Nuveen, 2019, 2.

226

Understanding the Positive Investor, Ethex 2017.

227

Consumer Survey, AXA Investment Managers UK, 2018, 19.

228

A Large Majority of Retail Clients Want to Invest Sustainably, 2˚Investing Initiative, March 2020, 30. See also Trond Døskeland andLars Jacob Tynes Pedersen, Investing with the Brain or Heart?
A Field Experiment on Responsible Investment, Management
Science, 2016, Vol. 62(6), 1632-1644 (Scandinavian individuals).

229

230

231

232

See, for example, Ann-Christine Brunen and Oliver Laubach, Do
Sustainability-Conscious Individuals Prefer Socially Responsible
Investments? A Study Among the Users of Robo Advice, 3 February
2021, available at https://ssrn.com/abstract=3778610 (German
individuals); Samuel M. Hartzmark and Abigail B. Sussman, Do
Investors Value Sustainability? A Natural Experiment Examining
Ranking and Fund Flows, Journal of Finance, 2019, Vol. 74(6),2789-2837 (US individuals); Daniel Brodback, Nadja Guenster andDavid Mezger, Altruism and Egoism in Investment Decisions,
Review of Financial Economics, 2019, Vol.37(1), 118-148 (German
individuals); Mariacristina Rossi, Dario Sansone, Arthur van Soest andCostanza Torricelli, Household Preferences for Socially Responsible
Investments, Journal of Banking and Finance, 2019, Vol. 105, 107120 (Dutch investors); Arno Riedl and Paul Smeets, Why do Investors
Hold Socially Responsible Investment Funds? The Journal of
Finance, 2017, Vol. 72(6), 2505-2550 (Dutch investors); Mortiz Wiesel,
Kristian Ove R. Myrseth and Bert Scholtens, Social Preferences andSocially Responsible Investing: A Survey of US Investors, Working
Papers in Responsible Banking and Finance, No. 17-002, University of
St Andrews, 2017 (US individuals); Sandberg and Nilsson, Do EthicalInvestors Want Purity or Effectiveness? (Swedish individuals); Jonas
Nilsson, Investment with a Conscience: Examining the Impactof Pro-social Attitudes and Perceived Financial Performance on
Socially Responsible Investment Behaviour, Journal of Business
Ethics, 2008, Vol. 83, 307-325; Nicolas P. B. Bollen, Mutual Fund
Attributes and Investor Behavior, The Journal of Financial andQuantitative Analysis, 2007, Vol. 42(3), 683-708 (US mutual fundinvestors).
Wins and Zwergel, Comparing Those Who Do, Might and Will
Not Invest in Sustainable Funds (German individuals); Wiesel,
Myrseth and Scholtens, Social Preferences and Socially Responsible
Investing: A Survey of US Investors (US individuals).
See, for example, Brunen and Laubach, Do Sustainability-Conscious
Individuals Prefer Socially Responsible Investments?; Ola
Mahmoud, Doing well while feeling good, March 2020, available
at SSRN: https://ssrn.com/abstract=3458277; Wiesel, Myrseth and
Scholtens, Social Preferences and Socially Responsible Investing.
Although there is evidence to suggest that investors with ‘pro-social’
preferences consistently prefer options that are likely to have themost impact if given several options to compare: Florian Heeb, Julian
F. Kölbel, Falko Paetzold and Stefan Zeisberger, Do Investors Care
About Impact?, 25 February 2021, available at SSRN: https://ssrn.

com/abstract=3765659.
233

Heeb, Kölbel, Paetzold and Zeisberger, Do Investors Care About
Impact? (Dutch individuals); Mahmoud, Doing well while feelinggood (Swiss individuals); Wiesel, Myrseth and Scholtens, Social
Preferences and Socially Responsible Investing: a survey of US
investors (US individuals).

234

Most obviously Adam Smith in his Theory of Moral Sentiments, but
see also for example Timothy Besley and Maitreesh Ghatak, Prosocial
Motivation and Incentives, Annual Review of Economics, 2018,
Vol. 10, 411-438; Samuel Bowles, The Moral Economy: Why Good
Incentives Are No Substitute for Good Citizens (Yale University Press
2016); Roland Bénabou and Jean Tirole, Individual and Corporate
Social Responsibility, Economica, 2010, Vol. 77, 1-19.

235

See for example, Shalom H. Schwartz, Les Valeurs de Base de laPersonne: Théorie, Mesures et Applications, Revue Française deSociologie, 2006, Vol 47(4), 929-969, and Daniel C. Batson, Altruismin Humans (Oxford University Press 2010). For a discussion of this
topic in the context of financial markets, see David Rouch, The Social
Licence for Financial Markets: Reaching for the End and Why it
Counts (Palgrave Macmillan 2020), especially 88-90.

236See, for example, Jonas Nilsson, Segmenting Socially Responsible
Mutual Fund Investors: The Influence of Financial Return andSocial Responsibility, International Journal of Bank Marketing, 2009,Vol. 27(1), 5-31.

237

Sustainable Signals, Morgan Stanley Institute for Sustainable
Investing, 2019, 5, 9.

238

Retirement Reality Check, Natixis 2019.

239

Ethics and Investing, Allianz Life Insurance Company of North
America 2019, 1.

240

SII Attitudinal and Behavioural Research, Greg B. Davies andCentapse, 2017, 14.

241

Looking for the Best of Both Worlds, Natixis Investment Managers,
2019, 6.

242

Ethics and Investing, Allianz Life Insurance Company of North
America 2019, 3.

243

Wins and Zwergel, Comparing Those Who Do, Might and Will Not
Invest in Sustainable Funds.

244

The top three factors considered most important by respondents forinvestment decisions were (i) avoiding monetary loss, (ii) meeting
total investment return expectations, and (iii) generating the
expected income level. Investing in sustainable investments ranked
fifth. See Global Investor Study. Are people compelled to invest
sustainably?, Schroders, 2019, 11.

245

Attitudes towards socially responsible investment in Europe, BNP
Paribas Asset Management, 2019, 8.

246

Ibid, 4.

247

For example, according to the study by the UK Department forInternational Development, 71 per cent of the respondents ranked
return, 65 per cent ranked risk and 30 per cent ranked impact of
an investment among the five most important investment factors,
see Investing in a Better World, UK Department for International
Development, 2019, 11, 42. In a poll by Good Money Week, UK
investors were asked about their investment concerns: 39 per centanswered that they only care about making money, 1 per centstated that they only want to achieve a ‘positive difference to the

ACKNOWLEDGEMENTS

world.’ 22 per cent ranked both objectives as equally important. For
26 per cent, both aspects play a role, of which 22 per cent state thatthey mainly care about financial return, see Attitudes to Ethical andSustainable Investment and Finance in the UK, Good Money Week
Public Polling, 2017, 2 (https://www.goodmoneyweek.com/sites/
default/files/download/public_polling_report_2017_gmw.pdf).
248

Bauer, Ruof and Smeets, Get Real! Individuals prefer more
Sustainable Investments. While the respondents represented only
about 6 per cent of the membership of the relevant pension fund,the authors describe how they sought to establish the extent towhich the respondents were nonetheless a representative sample.
The group of individuals that responded to the second survey was
not identical to the first, but there was an overlap. There appears
to have been some moderation in support overall for the pension
fund’s engagement strategy in the second survey. However, support
remained well above 50 per cent and, significantly, 98.8 per cent of
those responding who had supported it in the first survey remained
supportive in the second and 76.8 per cent of those who had
previously been against it nonetheless indicated their agreement in2020 with the steps the fund had taken.

249

Delsen and Lehr, Value Matters or Values Matter?, 240, 252. The
usable response rate was 49.38 per cent and the authors sought toensure that the sample was representative, 249.

250

SII Attitudinal and Behavioural Research, Greg B Davies andCentapse, 16.

251

Global Investor Study, Schroders 2020, 4, 7, 9.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?

252

See especially, Walking the Talk, the Cambridge Institute for
Sustainability Leadership, 15.

253

Harrison Hong and Marcin Kacperczyk, The Price of Sin: The Effectsof Social Norms on Markets, Journal of Financial Economics, 2009,Vol. 93(1), 15-36.

254

Sandberg and Nilsson, Do Ethical Investors Want Purity or
Effectiveness?, 40.

Appendix 1

255

Although mutual funds attract both institutional and retail money, aportion of these fund flows directly or indirectly represents individual
investor assets, and the authors looked both at institutional and noninstitutional share classes finding a similar pattern.

Appendix 2

256

Hartzmark and Sussman, Do Investors Value Sustainability?.

257

Marco Ceccarelli, Stefano Ramelli and Alexander F. Wagner, Lowcarbon Mutual Funds, ECGI Finance Working Paper no 659/2020,
February 2021.

258

Marie Brière and Stefano Ramelli, Responsible Investing and Stock
Allocation, Amundi Working Paper 104-2021, January 2021.

259

Attitudes Towards Socially Responsible Investment in Europe, BNP
Paribas Asset Management, 2019, 4.

260

Investing in a Better World, UK Department for International
Development, 24.

261

Global Insights: What’s on investors’ minds, Return on Values, UBS
Investor Watch Volume 2, 2018, 4, 9 et seq.

262

Ethics and Investing, Allianz Life Insurance Company of North
America 2019, 2019, 3.

263

Døskeland and Pedersen, Investing with the Brain or Heart?

264

Walking the talk, The Cambridge Institute for Sustainable
Leadership, 8, 14, 16 et seq. The 2,096 US individuals who

Appendix 3
Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

70

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTSINVESTING FOR SUSTAINABILITY IMPACTFOREWORDSINTRODUCTION
participated in the experiment were asked to make certain
investment decisions, with some of them, randomly selected,
receiving a real investment worth $1,000 in their chosen fund.
Therefore, the participants were told and encouraged to treat
all their choices as if they were investing their own assets. Given
information about financial returns and sustainability on a fact sheet,the participants were asked to choose one of two offered funds toinvest in.
265

Gunnar Gutsche and Andreas Ziegler, Are Private Investors Willing
to Pay for Sustainable Investments? A Stated Choice Experiment,
MAGKS Joint Discussion Paper Series in Economics, No. 40-2016, 16.

266

Jean-François Bonnefin, Augustin Landier, Parinitha Sastry andDavid Themsar, Do Investors Care about Corporate Externalities?
Experimental Evidence, 23 September 2019, HEC Paris Research
Paper No. FIN-2019-1350, available at SSRN: https://ssrn.com/
abstract=3458447.

267

Ceccarelli, Ramelli and Wagner, Low-carbon Mutual Funds.

268

Heeb, Kölbel, Paetzold and Zeisberger, Do Investors Care About
Impact?; Riedl and Smeets, Why do Investors Hold Socially
Responsible Investment Funds?.

269

As at least one author of this report can attest.

271

Attitudes Towards Socially Responsible Investment in Europe, BNP
Paribas Asset Management, 2019, 3, 6.

272

Only 15 per cent of Americans covered by the Allianz survey,
mentioned above, knew what the expression ‘ESG’ stood for in an
investment context: Ethics and Investing, Allianz Life Insurance
Company of North America 2019, 1. In relation to the UK, see Clean
Slate, Green Slate: Public and Investor Attitudes to ‘Good’ Money
2020, UK Sustainable Investment and Finance Association, 2020, 5, 6.
In relation to France, 66 per cent of respondents in a study covering
French individuals owning at least one financial product stated thatthey had never heard of Socially Responsible Investment: see The
French and SRI, Ipsos for Vigeo Eiris and the FIR.
Gunnar Gutsche, Miwa Nakai and Toshi H. Arimura, Revisiting theDeterminants of Individual Sustainable Investment – The Case ofJapan, Journal of Behavioral and Experimental Finance, 2021, Vol.
30, issue c.

274

Global Investor Study, Schroders 2018, 5.

275

Investing in a Better World, UK Department for International
Development, 24.

276

Another UK survey conducted among 2,020 individuals revealed that
there is a high motivation to tackle the ‘big issues’ by supporting
progressive businesses to improve economic success in the longterm (61 per cent). However, the same survey found that 61 per centwould not know where to go for more information: Annual Triodos
Bank Impact Investing survey, press release 5 September 2018.

277

278

A Large Majority of Retail Clients Want to Invest Sustainably, 2˚Investing Initiative, March 2020, 5.

280Annual Triodos Bank Impact Investing Survey, press release 5
September 2018.

281

See for example, ‘Advisers predict more ESG investing in the wake of
Covid-19’, Standard Life, 1 December 2020, available at: https://www.
standardlife.co.uk/about/press-releases/advisers-predict-more-esginvesting-in-the-wake-of-covid19 (accessed 12 April 2021).

282

For example, one survey of UK advisers found that 78 per cent of
those polled thought that less than 50 per cent of their clients would
wish to invest in a portfolio with ‘an ESG steer or positive impact’,with 46 per cent claiming that less than 25 per cent would wish to
do so: ESG Survey Results, Square Mile Investment and Consulting
Research Limited, April 2020.

283

Saloni Sardana, ‘One third of advisers never consider ESG funds’, FT
Adviser, 12 June 2019.

284

Surfing the Wave, FE Fundinfo, 2020; Mike Webb, ‘Investors are past
the tipping point on ESG’, FT Adviser, 19 January 2021.

285‘Schroders UK Financial Adviser Survey: Optimism returns to UK
equities as advisers increasingly embrace ESG’, press release,
Schroders, 20 November 2020, available at https://www.schroders.
com/de/media-relations/newsroom/all_news_releases/schroders-ukfinancial-adviser-survey-optimism-returns-to-uk-equities-as-advisersincreasingly-embrace-esg/, accessed 19 April 2021.

See, for example, Wins and Zwergel, Comparing Those Who Do,
Might and Will Not Invest in Sustainable Funds.

270

273

279

This is also supported by a study of the impact of ‘climate labelling’on investors from six European countries which showed that it isparticularly effective as a ‘nudge’ towards climate-friendly investing
among ‘intuitive’ decision makers: see Alexander Bassen, Katrin
Gödker, Florian Lüdeke-Freund and Josua Oll, Climate Information
in Retail Investors’ Decision-Making: Evidence From a Choice
Experiment, Organization & Environment, 2019, Vol. 32(1), 62-82.
See MiFID II Sustainability Delegated Regulation.

286

Anders Anderson and David T. Robinson, Financial Literacy in
the Age of Green Investment, Swedish House of Finance Working
Paper 19-6, December 2020, available at: https://ssrn.com/
abstract=3353534.

287

Wins and Zwergel, Comparing those who do, might and will notinvest in sustainable funds.

288

Some of them do however cover forms of impact investing, forexample, SII Attitudinal and Behavioural Research, Greg B Davies
and Centapse, 2017, using the term ‘social impact investing’, and An
Evolving Landscape, 2019 Responsible Investing Survey, RBC Global
Asset Management, 2019, dealing, among other things, with ‘impact
investing’.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACTINTRODUCTION
1.

What is investing forsustainability impact?

2.

IFSI: Goal certainty, assessment of
impact and understanding an investor’s
contribution

3.

What portion of global AuM is currently
subject to investment approaches
involving IFSI?

4.

In what ways do people want
their assets invested to bring aboutsustainability impacts?
Appendix 1
Appendix 2
Appendix 3289

Many of the academic studies in particular seek to counter this effector assess the extent of any potential impact on the results.

290

Walking the Talk, The Cambridge Institute for Sustainability
Leadership, 11.

291

For an overview of studies on this point alone, see the Cambridge
Institute for Sustainability Leadership literature review referred to at
endnote 174.

292

See, for example, the work undertaken by the research teamin Walking the Talk, the Cambridge Institute for Sustainability
Leadership study, mentioned above, to ensure that sustainability
options were clearly described to participants. However, even theyhighlight the impact that the method of presentation may have hadon the results.

293

However, some studies do seek to break this down. See for example
Standard Chartered Sustainable Investing Review 2020, Standard
Chartered Private Bank, 2020.

ANNEXES294

Anjum Ubaid Siddiqui, The Demography of Socially Responsible
Investors across Countries and Time: A Systematic Review, Asian
Journal of Managerial Science, 2018, Vol. 7(2), 7-15.

GLOSSARY295

See for example Global Investor Study, Schroders 2020.

Supplement to Appendix 3

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

REFERENCES

71

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSIINTRODUCTION
1

2

A key objective of this project has been toassess how far the law requires or permits
IFSI. That is the subject of this Part B. As
noted previously, what legal rules requireor permit turns not just on their ‘black
letter’ (ie what they ‘say’), but also thecircumstances in which those rules areapplied. For example, in the case of IFSI
these circumstances may circumscribe
what is possible as a technical matter orin terms of cost (see Part A.2). In view ofthat, Part B looks both at the substanceof the relevant legal rules, and theinterrelationship between that and thecircumstances in which they are followed.
It is in four sections:

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS• Section 4 turns to the circumstancesin which legal rules relevant to IFSI
are applied in practice. As noted, thesecan have just as much impact on thepractical outcomes that result fromfollowing rules as what the rules actually‘say’. In particular, the section looks at
a possibility that has frequently beenraised with us in preparing this report:
whether aspects of the way investment
markets currently operate create a riskthat sustainability factors are given
insufficient weight in complying withlegal duties.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

• Section 1 explains our methodology.
• Section 2 deals with common themes wehave identified across all jurisdictions
concerning the sort of legal rules that
apply to different categories of investor,
even though the content of those rules
varies between jurisdictions. It also
considers circumstances that investors
will commonly need to take into accountin complying with legal rules eventhough investors’ specific situations
will vary. It therefore explains how it ispossible to reach a generally applicableview on what ‘the law’ requires or
permits in spite of this diversity.
• Section 3 summarises our findings

across the 11 jurisdictions covered by
the project on what the ‘black letter’ of
the law provides. The full jurisdictional
assessments are included as annexes tothis report.

72

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI1.

METHODOLOGY

3This section explains the methodology
applied in undertaking this project. It
outlines how the project was scoped
so as to cut through the complexity ofinvestment markets, focusing the analysis
on those jurisdictions, areas of market
practice and market operators that should
provide a reasonable picture of the whole.
It also explains the process followed.

world’s largest centres for investment
management. Factors considered inselecting them included GDP, the size ofthe institutional investment market by
AuM, industry interest and recent relevant
regulatory and policy developments. Fora high-level indication of the distributionof global AuM by investment location, seePart A.3.2.4.
6

1.1.1

‘Hard’ and ‘soft’ law and wider industry
practice• Australia;

4This report concerns whether legal rules
facilitate or confine IFSI. This requires ananalysis not just of the ‘black letter’ ofstatutes, regulations and legal judgements(ie the substance of the rules themselves),
but also of non-legally binding standards
and codes of practice, regulatory guidance
and formal industry initiatives where theseconcern the discharge of investors’ duties
since these could be relevant to what therules require or permit in practice. Sourcesof this sort are sometimes termed ‘soft
law’. Even where these sources have noformal legal status, they may nonethelessexpress standards of accepted conduct that
may be taken into account by courts andregulators in their decisions about what
investors are legally required or permitted
to do (see Part B.4, Box 5).

• Canada;

Jurisdictions covered
The jurisdictions included in our review
are intended to represent a cross-sectionof investment hubs, cultures and legal
traditions, while capturing most of the73

and rating agencies to lawyers andaccountants. Each of these groups issubject to different sets of legal rules.
The activities of each group can influence
investment management practice andamong other things, the way legal rules areunderstood and applied.
8

The following jurisdictions were selected:

Project scope

5

INTRODUCTIONACKNOWLEDGEMENTS

1.1

1.1.2

FOREWORDS• Brazil;• China;• the European Union;1• France;• Japan;• the Netherlands;• South Africa;• the United Kingdom (considering thelaws of England and Wales);• the United States of America.

1.1.3

Relevant investors

7

International investment markets arecomprised of many different sortsof operators, with distinct but often
overlapping roles, including asset owners,
investment managers, investment advisers,
broker-dealers acting as principal and/or as agent, investee companies accessing
the markets for funding and a host ofservice providers ranging from investment
consultants, index and research providers

However, it is not necessary to look at
every part of this investment ecosystem
to reach a view on the key question
for this project. That is because, at its
core, the answer depends on legal rules
as they apply to two groups of market
operators: asset owners and the investment
managers they appoint to manage assets
on their behalf. The project has therefore
focused on the legal position of these
two groups (see (a) and (b) below) while
nonetheless recognising the important roleof investment consultants and fiduciary
managers (as discussed at (c) below).

(a)

Asset owners

9

The position of institutional asset owners is
key in establishing how far the law requires
or permits sustainability factors to be taken
into account in the investment management
process. That is because they legally
hold and are responsible for investing asignificant portion of the world’s investment
assets, whether in the form of equities, debt(including fixed income instruments such as
bonds), other types of financial instruments(including units in collective investment
funds and derivative instruments such as
options, futures and swaps) or real estateand other non-financial assets.2

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
10

11

12

74

Asset owners’ legal powers over those assets
and the duties and discretions that apply
in managing them are fundamental to ouranalysis. What asset owners are required or
permitted to do is not just relevant to them.
It also shapes the obligations and discretionsof all other financial operators who assist
or advise them in managing their assets.
An asset owner delegating investment
management discretion is not generally able
to empower the manager to do something
it could not do itself. Similarly, to discharge
their own legal duties, investment
consultants and others advising an asset
owner will need to understand the extent of
the asset owner’s legal powers, duties anddiscretions to decide how best to advise. In
other words, there is a legal ‘cascade effect’
from asset owners to all those who directly
or indirectly provide services to them.
Various categories of asset owner are active
in financial markets. Each category is
subject to different legal rules, even within
the same jurisdiction. For the purposesof this project, we have focused on thethree largest categories of asset ownerby global AuM:3 pension funds, mutual
funds authorised for public distribution
and insurance undertakings (collectively
termed Asset Owners in this report).
A broad range of other types of asset
owners are also active in investment
markets, including sovereign investment
funds, unregulated funds, charitable
institutions and family offices. Some holdsignificant amounts of AuM. To keep theanalysis sufficiently focused, this report
does not consider the position of theseother categories.

Pension funds

Regulated mutual funds

13

14

Broadly, these are pools of assets that areinvested to produce a return to provide
income in retirement for individuals or
their surviving dependants. Pension funds
may be pre-funded by an employer and/or
by employee contributions (occupational
pension funds) or by private individuals(personal pension funds).4 Pension funds
generally have a duty to provide financial
benefits to beneficiaries. The time horizonsof those beneficiaries may vary widely,depending upon how close they are to
their retirement date. In some cases, thebenefits are defined so that investment
risk lies with the pension fund (‘defined
benefit’). However, it is increasingly
common for investment risk to lie largely
with beneficiaries (‘defined contribution’),but this does not detract from the fund’s
obligations to act in the financial interestsof their beneficiaries as a whole. Pension
funds are usually legally required to seek toensure that no one cohort of beneficiaries
is unfairly prejudiced to benefit another:
they need to seek to generate both near andlonger-term financial returns in ways thatbalance the interests of different cohorts. As
noted in Part A.3, estimated pension fundAuM globally stood at $52.5tn as at the endof 2020.5

15Regulated mutual funds allow investors
to pool their funds with those of otherinvestors and to invest in accordancewith specific investment objectives, so
spreading risks and sharing investment
costs. In contrast with pension funds,
mutual funds usually have a relatively
specific financial investment objective
and associated investment policy which
may reference particular markets, sectors
or benchmarks. The objective and policyof a mutual fund will be set out in its
constitution or prospectus and the fundwill be legally obliged to adhere to them.
Open-ended mutual fund AuM globallystood at an estimated $63tn as at the endof 2020.6 A significant portion of mutual
funds’ shares or units are owned bypension funds and insurers.7
The jurisdictional analysis set out in theannexes focuses on mutual funds, rather
than listed investment trust companies.
Units in the former are generally available
for subscription and redemption from thefund or its agent (ie the fund is ‘openended’) whereas shares in the latter aredealt through brokers. An exception to thisis exchange-traded funds (or ‘ETFs’). These
are open-ended mutual funds the units ofwhich are listed and can be dealt throughbrokers (with subscription and redemptionof units generally being handled between
the fund or its agent with large brokerdealers). This report covers the rules that
apply to ETFs as mutual funds, but not any
listing rules.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
Insurance undertakings
16

17

75

invested, often by reference to the value ofunits in investment funds managed by the
insurer or by other investment managers.
Insurance company global AuM stood at an
estimated $35.4tn by the end of 2019.9

The project covers both non-life and life
insurers. Legal assessments generally
assume that the relevant insurer isestablished as a body corporate.
In its origins, insurance is a financial
risk management tool in which theinsured party transfers the risk of apotential financial loss as a result of a
specified insured event to the insurance
undertaking, under an insurance policy.
The insurance company assumes the riskin exchange for monetary compensation,
known as an insurance premium.
Premiums are pooled and invested
pending the payment of claims. This mostaccurately describes general insurance
activities where the insurer writes policies
that provide policyholders with a payment
up to a specified amount upon theoccurrence of a defined event (for example,
flood or weather damage, or damage to aproperty or vehicle). Long-term insurance
products such as life insurance or pension
products are, on the other hand, generally8
more akin to investment arrangements
under which premiums paid by thepolicyholder are invested by the insurer
with a view to the insurer making apayment to the policyholder at some pointin the future based on the investment
return it has managed to generate byinvesting the premiums. In some cases, theamount payable is guaranteed or subject toa guaranteed minimum. However, it is now
more common for life contracts to provide
for payments on maturity that varydepending on the investment performanceof the assets in which the premiums are(b)

Investment managers

18

The most significant service provider
relationship for most asset owners, at leastin the day-to-day management of theirportfolios, is with investment managers(also referred to as ‘investment advisers’(especially in the US), ‘asset managers’or ‘fund managers’). Most asset owners
routinely delegate the management ofsome or all of their assets to one or more
external investment management firms,10
and Part A.3.2.2 provides an indication of
the substantial value of assets now under
external management. The investment,
stewardship and policy engagement
practices of these firms are therefore
also of key importance in considering theextent to which the law requires or permits
IFSI. Consolidation in the investment
management sector means that someof these firms have now grown to havesignificant influence over the activities ofinvestee enterprises.

19

Asset owners may appoint multiple
investment managers. The investment
management market is diverse and firms’
business models fall across a broad range.
Some firms may specialise in particularasset classes, jurisdictions or investment
strategies. The growth in AuM committed
to passive investment management
strategies is particularly notable (seePart A.3.2.3), with potentially significant

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

implications for the extent to which legal
rules could require or permit IFSI and whatthat might mean in practice.
20

Investment managers, particularly thelargest, are therefore potentially importantin the context of IFSI. Among other things,
as individual firms, they can effectively
perform an aggregating role in relation
to their clients’ assets, with possible
implications, for example, in terms ofthe cost and likely effectiveness of theirdecisions. Further, where a number ofthese firms act in a common way towards
investment selection or stewardship (either
co-incidentally or intentionally), this could
have an even more significant influence
on investee enterprises and hence therealisation of sustainability impact goals.
Equally, however, it has been suggested to
us by some that growing consolidation in
the sector may leave asset owners with lessscope to define the services they receivefrom their managers, including in relation
to areas relevant to IFSI.

(c)

Other service providers not covered bythis report21

As noted, investment managers are notthe only service providers to asset owners
whose activities could affect the extent of
IFSI. While there are variations between
jurisdictions, two of the other mostimportant categories of service provider
are investment consultants andfiduciary managers.

22

Service providers such as these play a keyrole in the investment process. However,their legal duties are ultimately largely
derived from those of the asset owners

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
they act for. In some ways, therefore,
their legal position is similar to that ofinvestment managers. In view of that, in
the interests of picking out the key legal
principles applicable to IFSI across thejurisdictions covered, it was decided not toundertake a detailed assessment of theirlegal position at this stage. For the reasons
noted, however, the findings of this report
are clearly potentially relevant to how theyshould go about providing their services inorder to discharge their duties.

Fiduciary managers
24

Investment consultants
23

76

Investment consultants are a key service
provider for many asset owners. The
market is dominated by a relatively small
group of firms. They generally provide
strategic advisory services, potentiallycovering a wide range of areas, suchas funding decisions, asset allocationand selection of investment strategies,
stewardship strategy, manager selection
and relationship management, andperformance reporting. They may train
asset owners on investment approaches
and current market issues and trends.
Their influence on investment practice,including attention given to sustainability
factors and the use of approaches thatwould involve IFSI, is therefore potentiallysignificant. Having considered aninvestment consultant’s advice, the asset
owner ultimately takes any decisions, andretains accountability to its beneficiaries
for the decisions it makes.11

Fiduciary managers are a more recent
addition to the investment landscape but
are nonetheless an important part of it
in some jurisdictions.12 One of the maindifferences between them and investment
consultants is that fiduciary managers
combine advisory and implementation
services. Whereas investment consultants
provide advice, fiduciary managers put
some of their views into action, making
decisions on the asset owner’s behalf.13
The precise scope of their implementation
powers can vary considerably between
the asset owners that use them, eachrelationship being bespoke.

1.1.4

The meaning of ‘beneficiaries’ in thisreport25

In this report, beneficiaries are the persons
who derive a financial benefit from asset
owners’ investment activity. The expression
should therefore not be understood as
referring to a beneficiary relationshipin the strict legal sense. It includes, forexample, the members of pension schemes,
unitholders of mutual funds and longterm insurance policyholders. It may
also include wider categories of person
entitled to receive benefits in relation tothese investment arrangements, such as
dependents of pension scheme members
and nominated recipients of benefits (forexample, on the death of a life insurance
policyholder).

26

In the case of insurance undertakings,
we have also treated the idea of a‘beneficiary’ as including shareholders.
While shareholders do not have a directinterest in the assets of the company, they
nonetheless have an interest in the successof the company, including its capital growth
and the dividends it is able to pay. These
are both partly dependent upon how thecompany manages its assets, both those
held in relation to its insurance activities
and other ‘house’ assets. Many insurancecompany shareholders will be asset owners
and are therefore likely to want to see thecompany run in ways that will help themto discharge the duties considered in thisreport and in a manner consistent with any
goals they set in exercising their discretions.
1.1.5

Types of investment activity covered27

The report focuses on investment
management activity across all asset
classes. As discussed in Part A.1.3 there isalready a group of investors that engagein ‘impact investing’. However, what havetraditionally been regarded as impact
investors are not the focus of what follows.

28

Consistent with the description of
IFSI in Part A.1 the legal teams thathave prepared the jurisdiction-specificmemoranda have considered the legal
framework applicable to investment anddivestment decision-making, stewardshipof portfolio assets and public policy
engagement, in each case, as relevant
to IFSI. In the past, legal attention toinvestors’ duties has tended to focus
on the first of these. Decisions on
portfolio composition are clearly of great
importance in discharging investors’
duties. However, investors’ stewardship
activities in relation to their assets are also
potentially relevant to portfolio outcomes

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
and there has been an increasing emphasis
on it in recent years from policymakers,
legislators, regulators and industry.
29

covered in the jurisdictional analysis forinclusion in the report were then refinedin the light of that with the assistance ofthe reference group and the jurisdictional
legal teams. The legal teams then prepared
the jurisdiction-specific memoranda,
annexed to this report. These provide anassessment of the extent to which the law
in each jurisdiction requires or permits
IFSI. While they are the product of athorough exercise, and are substantial,
they should not be treated as legal advice
or an exhaustive statement of the law
on the areas they cover. Rather, theirprincipal purpose has been to provide
a solid basis for understanding the way
investment approaches within the scope of
IFSI are generally treated as a legal matterinternationally. Our overall conclusions onwhat the black letter of the relevant legal
rules requires or permits are set out in thelegal assessment summary in Part B.3.

Investors deploy a considerable variety
of investment strategies. The strategies
selected may have implications for aninvestor’s scope to engage in IFSI (see Part
B.2, Box 3). It is not feasible to consider thetreatment of all of the possible strategies
in an exercise of this sort. Consequently,
the base analysis assumes a reasonably‘standard’ active investment approach.
However, given the growing importance of
passive investment strategies, the report
also addresses the relevance of IFSI toinvestors using these.

1.2

The process followed in preparing
this report30

Producing this report has been an iterative
process involving legal expert teams ineach jurisdiction covered and a referencegroup established by the UNEP FI, PRI and
the Generation Foundation. Each legal
team undertook an initial assessmentof the relevant legal frameworks. The
scope of the review and the topics to be

31

The suggested areas for legal reform in Part
C.2 have also been tested with the legal
teams in each jurisdiction.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

77

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI2.

INVESTING FOR SUSTAINABILITY IMPACT: DIFFERENT LEGAL REGIMES BUT COMMON THEMES

32

The legal rules that apply to different typesof investor vary considerably between
jurisdictions.14 Their content, interpretation
and application reflect the social, economic
and political history of the jurisdiction
concerned.15 Even within a jurisdiction,
there are different rules for different
categories of investor, and the circumstancesof each investor are unique. Because of
these differences, precisely what an investor
is legally required or permitted to do in
relation to IFSI will be specific to thatinvestor so that investors need to consider
their position on a case-by-case basis.

34

Nonetheless, the answer to the questionof whether an investor is required or
permitted to engage in IFSI depends upon,broadly, four things:

2.1

Categories of difference in legal
treatment between different investors
within a given jurisdiction

35

Four of the main categories of variation
in investors’ legal powers, duties anddiscretions within a given jurisdiction are
as follows.

2.1.3

2.1.1

Different rules for different categories
of asset owner

Different rules for investment
managers

38

36

While there are functional overlaps
between the categories of asset ownercovered by this report, the purpose
pursued by each category is different.
Consequently, each tends to be subject
to legal rules that are specific to thatcategory. Pension funds are committed
to providing retirement finance, whereas
insurers are commercial enterprises
designed to make a profit. Insurers benefit
shareholders, among others, by providing
various forms of benefit to policyholders.
Some pension funds and insurers offer
defined benefits, and therefore retain theInvestment managers operate under adifferent legal framework from asset
owners. Asset owners have the ultimate
power to make investment decisions.
However, as noted in Section A, all but thelargest usually delegate implementationof their investment strategy to investment
managers who are therefore agents of
the asset owners. While the overall legal
requirements are largely the same forall investment managers in a particularjurisdiction, the investment managementagreements under which managers
are appointed (while they have somefairly standard features) impose duties

33• what power the investor has been given

by law over relevant assets;• the legal duties that apply to it inexercising that power (which will bederived from and directed at achieving
the purpose of the power);• any legal discretions the investor has indischarging its duties; and• the investor’s specific circumstances.

The first three concern the legal rulesthat apply to the investor, and the fourth
the practical reality within which thoserules apply. Practical circumstances areimportant; as noted previously, what alegal rule requires or permits in practicedepends as much upon the circumstances
to which the rule is applied as the rule’s‘black letter’ (ie what it ‘says’).

78

In spite of this diversity, the following
highlights four common themes, acrossjurisdictions, in how legal rules differ
between investor types (see Section 2.1). It
also outlines a number of factors that justabout any investor will probably need toconsider in applying those rules, even if
circumstances differ from other investors(see Section 2.2). Because of these common
themes, it is possible to arrive at somebroad conclusions about what legal rules
generally require or permit in relation to
IFSI across the jurisdictions covered by thisreport (see Part B.3).

associated investment risk themselves,
while others leave the investment risks
principally with their beneficiaries.
Meanwhile, mutual funds are designed
to generate an investment return set out
in the fund’s prospectus in the form of
an investment objective, elaborated in its
investment policy.
2.1.2

Different rules for asset owners within
the same category37

The legal rules for asset owners are likely
to vary even between asset owners inthe same category. That is because asset
owners tend to be established under legal
instruments (such as contracts, articles ofassociation and trust deeds) which set out
their purpose and what they can do. While
there is a degree of standardisation, these
instruments are specific to the relevant
asset owner.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
on the manager which are bespoke toeach delegation. How far an investment
manager is obliged or entitled to engage
in IFSI will be governed principally by
the relevant agreement. Generally, anasset owner can only confer powers on an
investment manager which it has itself.
2.1.4

Different investment objectives

39

The fourth area of legal difference
emerges from the second and third but
is so important that it needs a separate
mention; it concerns the investment
objectives investors are required to pursue
in managing relevant assets. Investment
objectives are legally binding in thesense that they are established under thelegal frameworks previously mentioned.
Critically, they define the goal or goals an
investor is legally empowered to achieve,
consistent with fulfilling its purpose – its
investment objective. Consequently, theprecise nature of an investor’s investment
objective will affect whether an investor
is required or permitted to engage in
IFSI. It is possible, but currently unusual,for investment objectives to include
sustainability impact targets in addition tofinancial targets.

40

Two areas of variation between financial
investment objectives are particularly
important for current purposes:• the financial return which is targeted

and the level of risk that can be acceptedin pursuing it (see (a) below); and• the period over which the return is to begenerated (see (b) below).

79

The appointment of an investment
manager by an asset owner will normallyaffect both (see (c) below).
(a)Financial return41

In terms of the targeted financial
return, for example, a mutual fund may
have a precisely articulated financial
investment objective, referenced to agiven benchmark, whereas the investment
goals of pension funds are generally
determined based on the financial needsof beneficiaries (involving different
generations of beneficiaries whose needs
and interests will differ depending
upon their proximity to retirement).
Investment arrangements offering aform of ‘guaranteed’ or pre-determinedfinancial return have particularly precise
financial return targets, for example,
defined benefit pension arrangements
and guaranteed insurance products. With
these, it is not unusual for additional legal
rules to stipulate asset classes in which thesupporting assets can be invested in orderto minimise the risk that obligations are
not met, an example being the EU Solvency
II regulatory capital regime for insurance
undertakings. Investment objectives may
target generating income, capital growth,
or a mixture of both.

(b)Time horizon

42

The investment objectives of someinvestors may be to generate a particular
type of return on an ongoing basis (a primeexample being a passive investment fund).
In other cases (especially for pension funds
and the directors of insurance companies),

the duty may span both the short-term
needs of some groups of beneficiaries (orshareholders) and the longer-term needsof others, so that the interests of different
groups need to be carefully balanced.
Where economic systems are at risk
from declining environmental and social
sustainability, the effects will be felt by
those who invest in enterprises that are
dependent on those systems. The nature ofthese sustainability risks means that thelonger the period by reference to which
an investment objective must be met, themore likely it is that an investor will needto take them into account in deciding how
to discharge its duties. This is not to saythat sustainability factors cannot also havean impact in the short-term, as seen, forexample, in the case of climate change andthe steps taken to address it as a result of
the Paris Agreement.
(c)Investment objectives where there isdelegation to investment managers

43

Where, as is common, day-to-day
investment management has beendelegated to one or more investment
managers, individual managers will haveagreed investment objectives with theirclient. While those objectives are designed
to assist the asset owner in achieving
its ultimate investment objectives, theultimate investment objective and theinvestment objective set for the manager
will not necessarily be the same, either interms of the return objective or the time
period for achieving it. This is particularly
so where the manager is appointed bya pension fund. There is usually greater

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
alignment where the manager is appointed
by a mutual fund or is managing various
types of insurance assets. There is therefore
a risk (which must be carefully managed)that a manager’s shorter performancehorizon could cause its perception of thefinancial impact of sustainability factors todiverge from that of the asset owner (seePart B.4.2.4).
2.2

Circumstances that investors
commonly need to consider in
deciding how to apply legal rules

44

In all jurisdictions, institutional investors
generally need to consider all relevant
factors in deciding how to manage theirportfolios in accordance with applicablelegal rules. As sustainability factors poseBox 1
Taking account of sustainability factors in
the investment process: what is ‘financial
materiality’ and by reference to which time
period should it be judged?
This question is relevant both to what thelaw requires or permits in relation to IFSI and
the integration of sustainability factors in theinvestment process more widely.
The background to the question is the Freshfields
Report of 2005 in which, based on the law andpractice as it stood at that time, we stated as follows:‘Conventional investment analysis focuses on value,in the sense of financial performance. … the links
between ESG factors and financial performance
are increasingly being recognised. On that basis,
integrating ESG considerations into an investment
analysis so as to more reliably predict financial
performance is clearly permissible and is arguably
required in all jurisdictions.’16

80

financial risks and opportunities forindividual enterprises, they can clearlybe relevant to investment decisions.
Moreover, many sustainability factors
also concern the long-term health ofsocial and environmental systems on
which businesses and financial markets
depend: these factors therefore potentiallyconstitute a risk to whole markets and theinvestment return on all portfolios that are
exposed to them. As noted in Part A.1, risksof this sort are referred to in this report as‘systemic risks’.
45

Where risks or opportunities of this sortare relevant to investors in achieving theirinvestment objectives, investors will needto consider what, if anything, they can do

We indicated that investors discharging duties tosecure a given financial return should take ESG
factors into account where those factors could bereasonably expected to have a ‘material’ impact onfinancial performance, an approach which has been
confirmed in numerous jurisdictions since then.
Time period
The question of the time period by reference towhich materiality should be assessed has attracted
some limited regulatory attention as it concerns
investors’ stated investment objectives. However,
the issue is potentially multi-layered depending
upon the precise circumstances of each investor.
Very broadly, regulatory provisions or guidance tend
to focus on the time period by reference to which
the relevant portfolio must be managed – i.e. theperiod up to the point at which the investor must
discharge its duty to seek to meet its overarchinginvestment objective. In most cases, therefore,
the time period is likely to be derived from theinvestor’s investment objective itself, such as paying

by way of response (see Box 1). They will
want to consider the possible use of allavailable avenues including investment
powers (whether at the level of capitalor asset allocation, investment strategy
or individual investment selection),stewardship and policy engagement. In
addition, where an asset owner relies on
third parties such as investment managers,
investment consultants and fiduciary
managers in running its portfolio, it willneed to be confident that the relevant
third parties have the necessary experienceand capacity to deliver an effective
sustainability solution and that theterms of their appointment reflect their
obligation to do so.

retirement income at a particular point in time.
However, representations made to beneficiaries
about the period by reference to which a given
fund will be managed could also be relevant, forexample, where a mutual fund prospectus gives
an expected holding period for those acquiring
units in the fund. As noted in at Section 2.1.4, someinvestors have longer-term investment objectives,
others short-term objectives and others, particularly
pension funds, a mixture of both, so that theinterests of different cohorts of beneficiary need to
be balanced.
Yet in practice investment is a continuous process.
Investors do not settle on a particular portfolio
at the outset and stick with it throughout therelevant time period, regardless of interim
performance. Progress towards an objective isperiodically reassessed, investment portfolios are
re-balanced and investment approaches changed
as circumstances develop. Judgements on thefinancial materiality of factors relevant to theinvestment process are needed throughout.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSIThe starting point is that those judgements should
be made primarily by reference to the ultimate
time-horizon of the relevant portfolio, as describedabove. However, an investor may need to set
shorter-term investment objectives as part of a plan
for realising its longer-term objective, and against
which progress can be measured. This is likely to be
acceptable as long as the shorter-term objective isconsistent with meeting its ultimate objective. For
example, it should not result in inadequate weight
being given to risks that are not likely to becomematerial within that shorter-term but which
are nonetheless material in the context of theultimate time horizon. Here, a particular challenge
is that the bases for portfolio construction andperformance measurement may not adequatelyreflect longer term risks (see Part B.4 ).
Investors may therefore face a challenging
balancing act. 17 They need to keep their longerterm objectives (and the risks and opportunities
that may emerge in that longer-term) clearly inmind. They also need to make sure that the needsof any beneficiaries with shorter-term horizons
are catered for, and to be reasonably satisfied
that any comparative short-term portfolio underperformance that cannot be avoided, for example,
by careful asset allocation, 18 or that is unlikely to
be offset by market repricing to reflect a moresustainable outlook, will not affect their ability
to achieve their longer-term objective. They will46

As noted, no two investors are alike, so theoutcome of one investor’s assessment may
differ from that of another. However, mostinvestors are likely to need to consider
the following in determining how theyshould act, in addition to their particularinvestment objective:

need to bear in mind the possibility that it may
not be possible accurately to predict when andhow some financial risks created by sustainability
factors could materialise. Investors may nonethelessbe concerned that short-term under-performance
could leave them open to criticism, or worse, even if
it is not necessarily inconsistent with achieving theirlong-term objectives.
Financial materiality
The law and associated guidance in thejurisdictions covered by the project has relatively
little to say about what should be regarded as
financially material for these purposes. Concepts ofmateriality do appear in other investment contexts,
in particular, corporate disclosure, market abuse
and insider dealing regimes. However, it is not
appropriate to apply a simple read-across fromthose to the investment rules considered by thisproject. Those regimes focus on the materiality of
unpublished information to a potential buyer orseller of an investment (and hence its market price),and do not generate (either in theory or in practice)
precise numerical tests. From the perspective offinancial return, this project concerns the potential
risks and opportunities created by sustainability
factors for the performance of a portfolio as a wholeover a particular time period and that is no more
susceptible to precise testing.

It is reasonable to suppose that the longer theperiod by reference to which materiality is assessed,
the more likely it is that some sustainability-related
systemic risks (such as those arising from climatechange, resource scarcity or biodiversity loss) willneed to be treated as financially material. That is
not to suggest that they cannot also have financial
impacts within a shorter period or that the timing
is easily predictable.

Ultimately, the question of what is financially

INTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM• the size and composition of the portfolio;• the extent of the investor’s ability(or that of its investment manager(s))
to influence particular areas ofsustainability impact (for example, howmuch ‘voice’ does it have in the affairs ofinvestee enterprises);• the relative likelihood of different

approaches achieving an impact (for81material as a legal matter within the time periods
considered above must be a decision for each
investor based on its own particular circumstances,taking account, among other things, of the factors
outlined in Section 2.2, as relevant. However,
the key legal consideration will be the investor’s
investment objective. In our view, a sustainability
factor is likely to be material if a reasonable
investment professional would conclude that
there is a reasonable prospect of it having (alone
or in combination with other factors) a significant
impact on the investor’s ability to achieve its
investment objective(s) over the relevant period(s).
This judgement would include both an assessmentof the probability of the impact occurring within
the relevant period and the financial consequences
for the portfolio if it did.

FOREWORDS

example, as noted in Part A.1.2, insome cases stewardship may be more
effective than investment/divestment,
and vice versa);• the variety of potential stewardshipstyles and techniques, ranging from
simply engaging in public votes (forexample, pursuing a policy of always
supporting shareholder resolutions

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
encouraging companies to disclosesustainability risk assessment andtransition plans) to deep engagementwith company boards;• the expenses for the portfolio of any

proposed action (for example, the costof maintaining a team of analysts) andwhether these are justified given the
anticipated benefits, recognising that
expenses and benefits may not always
be easy to quantify and a simple costbenefit approach may not be feasible orappropriate (see Part A.2);• any direct or indirect impact ofthe proposed action on investment
performance in the portfolio (forexample, where pursuing a long-termsustainability goal, such as convincing
companies to commit to carbon
neutrality, could impair shorter-term
financial results of those companies);• the extent and timing of any positive or

negative portfolio performance impact(including the relative likelihood of it
occurring within an asset owner’s time
horizon), and whether one approach
results in it being more equitably shared
between different cohorts of relevant
beneficiaries than another;• where an investor’s performance inseeking to meet its financial objectives

is likely to be assessed against common
market benchmarks and models, thefact that stewardship activities do not
generally affect the composition of aninvestment portfolio, so that they may
therefore be less likely than the use ofinvestment powers to affect portfolio
performance measured against thosebenchmarks and models (see Part B.4);

negative performance impact on theportfolio (or ensure that it is distributed
more evenly between cohorts), bystimulating or engaging in collective
action to address the issue concerned(see Box 2); and• the investor’s particular market

environment including the way inwhich sustainable investing in generalis becoming more prevalent (see Part
A.3.3), the factors that are driving this(see Box 3), and whether these may makeit more likely that IFSI activities willachieve their goal.

• the dynamic nature of investment

risks and opportunities created bysustainability factors, among otherthings, as a result of:– the methods selected by businesses

and societies generally to pursue key
sustainability targets (for example
where these end up relying on one kindof technology more than others); and– the extent to which thosesustainability targets are likely
to be fully achieved (ie there is awide range of possible transition
pathways towards a more sustainableequilibrium some of which may
involve societies achieving theirsustainability targets more fully thanothers, with their likelihood changing
over time);• whether the investor can enhance theprospects of realising a desired impact,
reduce its expenses and minimise47

An investor’s strategic and policy decisions
will also affect the way sustainability factors
may subsequently be taken into accountin ‘lower-level’ decisions about how thosestrategies and policies are implemented.
While strategic and policy decisions of
this sort generally need to be kept underreview, an assessment by one investor ofits circumstances (including sustainability
factors) may properly lead it to pursue a
different strategy or investment policy fromanother investor in seeking to achieve its
financial goals. Box 4 looks further at thecase of strategy selection.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

82

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSIBox 2
The importance of collective action to achievesustainability impact
Collective action to achieve sustainability impact
goals can strengthen the voice of the investors
concerned, allow for a more strategic approachand help to spread the cost of engagement
reducing the unit costs for individual investors.
Importantly in the context of any decision to
engage in IFSI, it can also increase the likelihoodthat the sustainability impact goal being aimed
for will actually be achieved. It can involve any of
the types of activity considered in this report: theuse of investment powers, stewardship and policy
engagement. It can also take other forms, suchas providing investment analysis that can support
the IFSI activities of other investors19 or working
with third parties whose activities may assist or
encourage investee enterprises or policymakers inseeking to achieve sustainability impacts.
Taking the case of stewardship, while eachsituation needs to be considered on its own
facts, the larger the enterprise and the smaller
an asset owner’s investment in that enterprise,the less likely it is that individual stewardship will
influence enterprise behaviour. That, and otherfactors such as the costs involved and ‘free-rider’
issues, could tend to militate against individual
investors engaging in stewardship activity.20 Thisis particularly the case where action is neededto address systemic risk, and not simply to deal
with sustainability risks and opportunities thatare specific to an individual enterprise: systemicrisks tend to be the result of what are sometimes
called ‘collective action problems’ which requirewidespread coordination to resolve, whereas
individual investors and investee enterprises are
single actors. For example, in the case of climatechange, one study suggests that only half of thenegative portfolio impact of policy and market
reactions can be offset by asset allocation anddiversification strategies; more broad-based

83

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

approaches are needed in an attempt to manage
the rest.21
What investors’ duties may require with regard
to collective action will depend on theircircumstances. Some large investors may bein a position to catalyse wider collective action
because of the way their portfolio is exposed tosustainability risk, their broader influence or theirdifferent cost base. Where effective collective
action is already underway, smaller investors may
conclude that supporting it is a cost-effective
way to serve beneficiaries whose interests may bethreatened by declining sustainability.
There are now numerous examples of collective
action of this sort, and growing evidence thatthey do have an impact.22 It is often facilitated or
supported by forums, such as the PRI, the Global
Investor Coalition on Climate Change,23 Ceres24 andthe UK’s Investor Forum, or by UN bodies.25
In some cases collective action involves a formal
alliance including, for example, Climate Action
100+26, the Net-Zero Asset Owners Alliance,27 theNet Zero Asset Managers Initiative,28 the Investor
Alliance for Human Rights,29 FAIRR (addressing thesustainability of protein supply chains),30 the Global
Investors for Sustainable Development Alliance,31 andthe Dutch Responsible Business Conduct Agreement
on responsible investment by pension funds.32
In other cases, collective action involves lessformalised joint initiatives. Examples include, theinvestor statement on deforestation,33 investor
action on biodiversity,34 Investor Action on
Antimicrobial Resistance,35 the Investor Mining andTailings Safety Initiative,36 and investor action on
corporate human rights due diligence.3738
Any collective stewardship activity must takeaccount of a number of legal regimes that control
certain sorts of collective activity in relation tobusiness enterprises. These are discussed further inPart B.3. They will generally not prevent it, but may
impose constraints and cannot be ignored.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
Box 3
Responsible/sustainable investing and the wider
market environment for IFSI
Investor demand has driven significant growthin the level of AuM committed to sustainable/
responsible investment strategies (see Part A.3.3).
At least in part, this seems to be based on a belief
that ESG investing does not necessarily harm
investment returns and may even provide superior
returns as compared with non-ESG investing (seePart A.2, Box 5).
As noted in Section 2.2, what an investor must
do to comply with its legal duties needs to beconsidered by reference to all relevant surrounding
circumstances. Part A.1.4 noted the conceptual
mist that surrounds some forms of sustainable/
responsible investment and, as with all market
practice, investors need to think for themselves andnot simply follow market trends. Nonetheless, thestriking growth in sustainable/responsible investing
is potentially relevant to investors considering
whether their duties require or permit them topursue sustainability impact goals. Certainly,
the factors that seem to have driven this growthsuggest that investors would need to have goodreasons to justify a view that sustainability factors
are irrelevant to their decisions about managing
their portfolios.
Among other things, as noted in Part A.1.4, eventhough common forms of sustainable/responsible
investing may not usually involve pursuingsustainability impact goals, they could nonethelessencourage changes in investee enterprise practicethat are consistent with IFSI outcomes.
Factors that have focused investors’ attention onsustainability include the following:• ever-greater awareness of the risks thatsustainability factors can pose to portfolio
performance, particularly in the area of climatechange (the recognition that lies behind the
TCFD), and conversely the opportunities they
can provide;• a growing recognition of the speed with whichsome sustainability risks (and/or their financial
impact) may be materialising;• significantly more active government
intervention in the primary economy to securesustainability goals, with potential implications
for the value of investee enterprises;• heightened public, policy and regulatory
expectations on business enterprises and thecommencement of an increasing numberof sustainability-based legal actions against
business enterprises and others which havealerted investors to the possibility that investees
may be vulnerable to litigation and other sourcesof loss if they do not address sustainability risks
that they have contributed to;• heightened public, policy and regulatory
expectations that investment processes shouldtake account of sustainability factors, which are
likely to affect the way investment duties areunderstood and applied in practice;

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS• the possibility of strategic litigation against
investors that are considered not to be taking
sufficient account of sustainability factors;39• improving corporate disclosure and reporting
regimes, making it potentially more feasible tounderstand the role of individual enterprises in
helping to realise or undermine sustainability
goals (although, as discussed in Part A.2.2,
significant issues remain around the quality andquantity of the information);• the availability of increasingly reliable investment
analysis of the business and investment impact
of sustainability factors;• growing expertise and developing conceptual
frameworks in (a) sustainability assessmentand (b) the investment management
processes needed to address sustainability
risks and opportunities, both helping to bringsustainability factors into the investment
professional mainstream where, among otherthings, they could influence the way courts or
regulators apply legal rules (see Part B.4, Box 5);• the development of investor alliances andcoalitions focusing on various areas ofsustainability risk, making it easier for investors toconclude that there are ways in which they canmake an impact on those risks by cooperatingwith others (see Box 2 above); and• growing evidence that individuals want theirmoney to ‘do good’ as well as earning a good
return, and initiatives that are emerging to help
them to act on that (see Part A.4).40

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

84

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
Box 4
The impact of investment strategy selection on
the scope for IFSI
Another key area of difference between investors,
which will also affect how far they are legallyrequired or permitted to pursue IFSI, is theirchosen investment strategies. Investors may
select from a range of different investment
approaches in seeking to achieve their financial
investment objectives. The most obvious
difference in strategies is between passive andactive investment management. However,active management, especially, can come invarious forms. These range from approaches that‘hug’ an index to those that are highly activist,and from those that are more concerned withthe underlying value of investee enterprises(particularly ‘value investing’ and ‘growth investing’)
to those that are more like trading strategies basedon anticipated movements in investment prices(such as ‘momentum investing’). Investors may also
use quantitative and algorithmic strategies the firstof which relies on investment transactions basedon fixed rules and reversion to the mean, withthe latter commonly used as a trading more thaninvestment strategy (especially short-term or highfrequency trading).41 Strategies may be pursued byinvesting in the instruments issued by a businessenterprise, in units in funds that do the same, or
synthetically by entering into derivative contracts(directly or indirectly through funds) that provide
exposure to underlying securities.

Investors need to consider all factors that arematerial to achieving their investment objectives,potentially including sustainability factors, indetermining which strategy or strategies touse (see Box 1). With just about any strategy
selected, in principle, there is scope to pursue
sustainability impacts by undertaking stewardshipand public policy engagement.42 Further, mosttypes of strategy can be pursued in ways that takeaccount of sustainability factors in the process ofinvestment selection, even in the case of passive
strategies, for example, by choosing to replicate
an index which does so. Some passive strategies
may also be pursued in ways that allow for adegree of discretion over precisely what is heldin the relevant portfolio (for example, where themanager engages in sampling). Nonetheless,having taken account of all relevant factors indeciding which strategy to pursue, an investor
might properly select a strategy which thenrestricts its scope for taking sustainability factors
into account in the context of investment selectionin the course of pursuing the strategy. The investor
would nonetheless need to keep the continuing
appropriateness of its strategy selection underreview, with sustainability factors, again, potentiallybeing a relevant consideration.
While differences of strategy such as these might
be thought most relevant to the use of investment
powers to engage in IFSI, they could in practicehave implications for the attention an investor
devotes to stewardship and policy activities (seePart B.4, Box 6 which concerns the impact ofdiversification on stewardship decisions).

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

85

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
3.

IFSI IN ELEVEN JURISDICTIONS - SUMMARY OF FINDINGS

3.1

Introduction

48

The following:
characteristics of Asset Owners’ andtheir investment managers’ duties,
as relevant to IFSI, across the elevenjurisdictions (Section 3.2);• summarises our findings on how far

51

Asset Owners are required or permitted
to use investment powers, stewardshipand policy engagement to pursue
sustainability impact goals (Sections 3.3
to 3.5);and their investment managers shouldseek to achieve those objectives (eg to
exercise powers with a prescribed levelof care or skill and rules on managing
conflicts of interest) (Section 3.2.2; andinvestment managers could incur legal
liability to third parties for any negative
sustainability impact of investee
enterprises (Section 3.7).

3.2

Common characteristics of investor
duties relevant to IFSI in thejurisdictions covered

50

While the law in each of the jurisdictions
surveyed is unique, there are nonetheless86• the legal duties of the officers of thatlegal vehicle, those who make decisions
on its behalf, which are generally owed
to the vehicle itself.

In all jurisdictions, relevant legal
rules involve:• duties concerning the way Asset Owners• looks at whether Asset Owners andThere has been significant growth in newlegislation and regulations addressing
the relationship between investors andsustainability goals. More is in progress.
What follows is based on the law as
at 31 January 2021 but does draw onforthcoming changes to the law where
sufficiently certain and material to theanalysis.

the duties that vehicle owes to othersin pursuing it, especially those who areintended to benefit from its investing
activity; andWhere an Asset Owner does not takethe form of a legal vehicle, for example
a contractual or trust structure, there islittle distinction, so that the individuals
operating the arrangements will likely
owe duties directly to those intended tobenefit from the arrangements.

Asset Owners and their investment
managers must pursue (eg achieving aparticular financial outcome); in thiscontext, we look specifically at how IFSI
can contribute to achieving a financial
return objective (Section 3.2.1 and 3.2.3);

position of investment managers and
IFSI (Section 3.6);49• the legal purpose of the legal vehicle and• requirements as to the objectives that• summarises our findings on the legal• often, more specific requirements andrestrictions about what they must do (egon the type of investment that can be
included in a portfolio).
52

53

The following section looks further at thefirst and second of these. Investors may
be given some discretion as to the precise
outcomes they should seek in the firstcategory and generally have discretion as
to how they go about discharging duties inthe second category.
Where an Asset Owner takes the formof a legal vehicle, such as a company, adistinction must be made between:

INTRODUCTIONACKNOWLEDGEMENTS

similarities in the way different
jurisdictions categorise and regulate
investors (see Part B.2). Beyond that,
however, there are also some common
features in the substantive duties
that apply to Asset Owners and theirinvestment managers.

• provides an overview of common

FOREWORDS

54

When discharging their duties, there are anumber of considerations that are relevantto the decisions of investors and theirofficers across all legal frameworks coveredin this report (see Section 3.2.4 below).

3.2.1

The purpose of investment activities
and the relevance of financial return55

As noted, in some cases investors havea degree of discretion as to some of theobjectives they can pursue. However, inall jurisdictions, the principal purposeof the investment activities of Asset
Owners and their investment managers is
generally regarded (by lawmakers, courts
and investors themselves) as generating
financial returns, within acceptablelevels of risk. In no jurisdiction is there arequirement to exercise investment powers
to maximise financial return at all costs.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
Rather, duties generally require decisionmakers to consider both risks and potential
returns, subject to applicable laws.
56

57

58

87

Particularly for pension funds, the goalof financial return tends to be expressly
established in legislation, at least in broad
terms, with Asset Owners being left todefine what it means in their particular
circumstances.43 For mutual funds, thegoal will be defined by the investment
objective and policy of the fund,established when the fund was launched(as amended thereafter) and set out in thefund’s offering documents. It is for the
directors of an insurer to determine its
goals, including its financial goals, within
the context of its overall purpose. They
are generally likely to have the greatest
discretion out of the three types of Asset
Owner as to what these goals should be,
but it is usually understood that theyshould seek to achieve a certain level offinancial return. The terms of investment
products issued by long-term insurers will
also likely impose particular requirements
for a large proportion of their assets.

some jurisdictions and for some
types of Asset Owner this should be thesole purpose.44
59

3.2.2 General duties of Asset Owners andinvestment managers as to the way
they pursue their objectives
60

The financial goals of investment managers
are set by the terms of their investment
management agreement with their client
but should reflect the financial goals of therelevant Asset Owner client.
The upshot of this is that for most pension
funds, regulated mutual funds and, inpractice, insurers, investment decisionmakers will generally need to act primarily
to secure optimal financial returns, within
acceptable risk levels, over the appropriate
investment timeframe of the portfolio. In

Where that is the case, the Asset Owner
would not be able to engage in ultimate
ends IFSI but might still conclude that
instrumental IFSI is required or permitted.
Other jurisdictions allow certain types ofinvestor to pursue additional purposesin parallel with financial goals, even
where not expressly set out in the termsof the investment arrangement. Where
those wider purposes are consistent withpursuing sustainability impact goals, thenthose investors would potentially be able
to engage in ultimate ends IFSI and to give
their investment managers the discretion
to do the same.

61

As a preliminary observation, it has
become common in the investment
sector to refer generally to the duties thatinvestors owe in managing their portfolios
as ‘fiduciary duties’, regardless of the sortof investor concerned or the jurisdictionin which it is located. For various
reasons45 this is not technically accurate,
so this report generally avoids using theexpression ‘fiduciary duties’, referringinstead to the standard of behaviour orgoal set by the duty.
Similarities in the most importantinvestment-related duties owed by Asset
Owners and their investment managers are
as follows:

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS• Asset Owners and investment managers

generally owe duties to exercise anappropriate level of care and skill inseeking to achieve their legally defined
purpose. Precisely what standard of careis required and how it is articulated
will vary between investors, but dutiesof this sort tend to reference whata reasonable or prudent person or
investor in their situation would do insimilar circumstances. These duties
can arise under legislation, general law(such as tortious duties in common
law jurisdictions) or in the express or
implied terms of the relevant investment
arrangement.46 Sometimes they canbe altered by agreement between therelevant parties.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

• Duties owed by individuals in theircapacity as officers of legal vehicles,
as described above, also involve
requirements as to applying anappropriate level of care and skill, but
those duties are ordinarily owed to thelegal vehicle and must be exercised in theinterests of the vehicle.47 In this report,
this is particularly relevant for insurers
established as companies. Their directors
generally have to discharge their duties in
the interests of the insurer.
• In many cases, decision-makers have aduty to consider whether their personal
interests or the duties they owe toothers conflict with their duties to thebeneficiaries or the legal vehicle on
whose behalf they are acting and, if so,
how to manage those conflicts so thatthey do not disadvantage the relevant
legal vehicle or beneficiaries, or so

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
that they are treated fairly. Conflicts ofinterest might arise, for example, if apension fund pursued investment goals
for the benefit of one set of beneficiaries
which harmed the interests of otherbeneficiaries, as might happen where
it puts undue emphasis on short-term
financial return at the expense of steps
to secure longer-term value growth orvice versa. Common law fiduciary duties
of loyalty are a prime example of thissort of duty. Among others, they apply tothe relationship between a trustee andits beneficiaries, an investment manager
and its clients and a director and the
director’s company. However, financial
services regulatory rules often impose
similar standards and there are duties
that are similar to this duty of loyalty incivil law jurisdictions.
62

88

Legal duties of the sort outlined above
are usually concerned with how investors
seek to achieve their legally defined goals,
including whether they pursue a proper
objective and follow a proper process,rather than whether, with the benefitof hindsight, they succeed in achieving
the optimal result.48 Where investors
have, in good faith, aimed for a proper
objective and followed a proper process,courts or other relevant authorities areusually reluctant to review the merits ofcommercial decisions. So, an Asset Owner
or investment manager is unlikely to be
automatically liable to those to whom it
owes its duties simply because its portfolio
underperforms. Rather, a court would
consider, among other things, the objective
or objectives the investor was required

to pursue and the process the investor
followed in seeking to do so, assessing
whether these were consistent with therelevant standard of care and any otherprocess-related requirements. If so, then it
is unlikely that the relevant duty will havebeen breached.
63

Financial return and instrumental IFSI

64

Negative sustainability outcomes canclearly be a threat to the long-term
prosperity of any business. Indeed, somesustainability crises, such as climatechange, pose systemic risks that arelikely to damage the prosperity of wholebusiness sectors and societies. This is themain reason for a potential obligation toconsider engaging in instrumental IFSI.

65

There is no doubt that Asset Owners andinvestment managers have a duty tounderstand sustainability risks relevant totheir ability to achieve the financial goals
they are required to pursue and to takethese into account as appropriate in theirinvestment process. We consider that thiswould be accepted as the position in all thejurisdictions surveyed and is the starting

INTRODUCTIONACKNOWLEDGEMENTS

point for our discussion of IFSI.
66

Following a correct process usuallyrequires decision-makers to have regard
only to factors which they have, or ought
to have, identified as relevant to thedecision, and to use their powers only forthe purposes for which they are intended.
What is a proper purpose will be shapedby the terms of the particular investment
arrangement, and especially theinvestment objectives that the Asset Owner
or investment manager is legally requiredor permitted to pursue.

3.2.3

FOREWORDS

Notwithstanding the relative absenceof court decisions specifically on thequestion, we consider that based on its
general duties an Asset Owner would, if
one or more sustainability factors poseda material risk to meeting its investment
objective over the timeframe that isrelevant to it, be legally obliged to consider
what steps it can take to mitigate the risk.
An Asset Owner would generally have alegal obligation to consider (within therange of options open to it) whether there
are reasonable steps it can take to bringabout specific sustainability impact goals
that can reasonably be expected:• to help influence the relevant

sustainability factor(s) or the exposure ofinvestee enterprises to it/them; and• to do so in ways that mitigate thefinancial risk for the portfolio, or evencreate potential for value growth;and, if so, to act accordingly. Possible
approaches might include use investment
powers, stewardship activities and/or policy
engagement.
67

In this report (and the underlying
contributions from each jurisdiction) a
distinction is drawn between obligations
to engage in IFSI and discretions to doso. However, in the case of instrumental
IFSI where a legal obligation arises, thisobligation is to consider the use of IFSI
as a possible response to material risks
to, or opportunities for, the investor’sgoal of achieving its financial investment
objective created by sustainabilityrelated factors. Where IFSI could be an

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
effective response to these risks, Asset
Owners and investment managers whoare subject to this obligation must still
exercise judgement on whether to engage
in IFSI and, if so, how, to what extent, andon what terms. In that sense, they need toexercise discretion as to how to discharge
their duty. However, having undertakena proper assessment and reached aconclusion on what they should do, they
will need to act accordingly.
68

69

89

would have a discretion, rather than an
obligation, to engage in instrumental IFSI;
for example, if it were to conclude thatparticular sustainability improvements
were likely to flow through to higher
returns (consistent with its financial
objectives) and then worked with aselection of investee enterprises to deliver
those sustainability improvements.
70

This exercise of discretion can becontrasted with situations where thesustainability factor in question is notmaterial to the investor’s financial goalso there is no legal obligation to consider
the use of IFSI in seeking to achieve it,
but the investor is still legally entitled or
free to pursue sustainability impact goals– what we are calling ultimate ends IFSI
– where a positive sustainability impact
is being pursued as an end in itself. Herethe discretion concerns whether to pursue
sustainability impact goals in addition to
the financial investment objectives theinvestor has a duty to pursue. This inturn contrasts with the admittedly rare
position where an investor is subject to an
obligation to pursue sustainability impact
goals independent of any financial goals.
The presence of a legal obligation ofthis sort in relation to instrumental
IFSI has been confirmed generally by all
jurisdictions covered by this report and
we anticipate that it is most likely to be
relevant where sustainability factors create
systemic risks. However, it is also possible
to imagine that there could be othercircumstances in which an Asset Owner

71

In practice, the legal standard for
determining whether a sustainability
factor constitutes a material financial risk
for these purposes differs a little fromjurisdiction to jurisdiction (see Part B.2,
Box 1). Ultimately, the question of what
is financially material as a legal mattermust be a decision for each investor
based on its particular circumstances(see further in Part B.2.2). However,
the key legal consideration will be theinvestor’s investment objective. In ourview, a sustainability factor is likely to
be material if a reasonable investment
professional would conclude that there isa reasonable prospect of it having (alone
or in combination with other factors) a
significant impact on the investor’s ability
to achieve its investment objective(s) over
the relevant period(s). This judgement
would include both an assessment of theprobability of the impact occurring within
the relevant period and the financial
consequences for the portfolio if it did.
In deciding how best to respond to thefinancial risks and opportunities posed bya sustainability factor, investors will needto balance the costs and risks of various
alternatives against their chances ofsuccess and the benefits for the portfolio if

successful (bearing in mind that the natureof some of the relevant portfolio risks andthe benefits of reducing them are systemic
and may not therefore reduce to simple
monetary quantification or cost-benefit
analysis – see the discussion of assessing
the impact of IFSI on financial performanceand of collective action in Part A.2, Boxes
5 and 6 respectively). They may also needto ensure fairness as between different
cohorts of beneficiaries.
72

73

Partly because of this, we anticipate thatstewardship and public policy engagement
may be a particular focus for an investor
considering whether it should pursue aparticular sustainability impact goal, as
compared with, for example, investment
in unproven new technology. This isparticularly the case where there is apossibility of acting collectively withother investors, given that this is likely
to enhance the effectiveness of these
activities. However, the use of stewardshipand public policy engagement would
need to be considered in the context ofany other means of influence available tothe investor, including using investment
powers. Investors may conclude thatthey should use (or threaten to use) theirpowers of investment and divestment tostrengthen ‘voice’ in stewardship activities.
In current conditions, it would usually
be unlikely that an individual investor
in secondary markets, acting alone andconsidered in isolation from wider market
dynamics, would be able meaningfully to
influence the sustainability impact of aninvestee enterprise solely through the useof its investment powers. However, it is

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
arguably not realistic to consider investors
as isolated actors in this way since theiractivities take place in a wider context,
and very large Asset Owners may be able
to influence that context. Nonetheless, itwould seem more likely that a group ofinvestors, acting collectively and holding
in aggregate a substantial portion of the
securities of relevant investee enterprises,or proposing to invest at scale, could
achieve an impact of this sort, especially iftheir proposed action is aligned with wider
market movements.

(b)

The need to take account of all relevant
circumstances, including costs andexpenses76

In deciding whether and how to pursue
a given sustainability impact goal,
investors will need to consider all relevant
circumstances (see Part B.2.2). In thecontext of instrumental IFSI, Section 3.2.3
touched on the need to balance the costs
and risks of various alternatives against
their chances of success and the benefits tothe portfolio if successful. However, these
considerations are relevant to any sortof IFSI. Where an investor has discretion
to engage in ultimate ends IFSI, they will
normally have to pursue a financial returnobjective and even where this is moderated
in some way (for example, in the case of
a mutual fund specifically established topursue sustainability impacts as well as
financial return), ensuring an appropriatebalance between costs and expenses andfinancial return will still be relevant toan investor in determining how best todischarge its duties.

3.2.4 Considerations potentially relevant tomore than one duty or discretion
74

Various considerations are likely to be
relevant to more than one of the duties
or discretions considered in what follows.
This section looks at a number of themore significant: (a) the use of all available
means in discharging duties and exercising
discretions; (b) the question of costs andexpenses; (c) collective action; and (d)managing conflicts of interest.

(a)

Use of investment powers, stewardshipand policy engagement interconnected

75

The legal teams in each jurisdiction haveconsidered separately the use of investment
powers, stewardship and public policy
engagement in discharging investors’ duties
and exercising their discretions. However,in practice, the relevant legal duties anddiscretions are likely to lead investors toconsider their use together.

90

77

Among other things, as noted in Part B.2.2,
Box 1, investors may need to seek to ensure
fair treatment between different cohorts ofbeneficiaries (see further below at Section
3.2.4(d)).

(c)

The role of collective action

78

As discussed in Part B.2.2, Box 2, where
an investor is seeking to achieve asustainability impact goal, in many cases
collaboration with other investors is likely
both to reduce the costs and to increase
the likelihood of a better sustainability
outcome, whether the investor is making

use of its investment powers, engaging
in stewardship or undertaking public
policy engagement. The possibility ofacting collectively is therefore potentiallyrelevant to achieving both the financial
goals of instrumental IFSI investors andthe sustainability goals of ultimate ends
IFSI investors: lower cost and increased
likelihood of success are likely to favour
a decision to act, whether in pursuit of aduty or the exercise of a discretion.
79

It is clear that cooperation of this sortis possible in all jurisdictions and asignificant number of collaborative
ventures are already underway at bothnational and international levels. However,those engaging in collective activity needto do so in a way that does not breachcompetition, insider dealing and market
manipulation, and takeover (and otherrelevant) rules. At the level at whichmuch collective stewardship is currently
undertaken, these regimes do not generally
create material impediments. Indeed,
regulators in a number of jurisdictions
have noted the importance of investor
cooperation in the context of stewardship
activity in particular, or have made clearthat the intention of these restrictions
is not to prevent legitimate stewardship
activities.49 However, if collective activities
were to become more intensive andcoordinated, competition regimes inparticular might need to be reassessed toensure that they do not impede legitimate
sustainability stewardship.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
80

81

91

In China, competition law provides an
exemption for collaboration arrangementsthat are intended to realise public interests
such as energy efficiency and conservation,
environment protection and provisionof disaster relief and assistance, all ofwhich may concern joint efforts designed
to achieve sustainability impact. Exempt
arrangements must also allow consumers
a fair share of the resulting benefits, andmust not significantly restrict competitionin the market (Section 3.1.5 China Report)
In the EU, agreements or coordination
between parties that restrict competition
are prohibited under EU competition
law. The parties to a collaboration
therefore need to consider whether
what they envisage could fall within
the scope of the prohibition of anticompetitive agreements. Collaborations
between investors to bring a common
influence to bear on investee companies isunlikely of itself to be considered anticompetitive, and it is also helpful that anunderstanding of the importance of clear
competition rules for collective action forsustainability impact is growing among
European competition authorities. The
Dutch national competition authority has
recently published draft guidelines that are
intended to provide guidance on, including
examples of, the types of sustainabilityfocused agreements that are permitted
under Dutch and EU competition law.
The EU Commission has subsequently
noted that it ‘fully supports the need forclear guidance’ on sustainability-focusedagreements and emphasised that it iscurrently looking into the same issues

and, on 13 October 2020, issued a callfor contributions for a ‘Competition
Policy supporting the Green Deal’, that
also aims to ‘identify whether there areremaining barriers to desirable agreements
supporting Green Deal objectives and if so,
how such barriers can best be addressed.’50(Section 3.1.6(c) EU Report, Section
Netherlands Report)(d)Conflicts of interest and duties to act inbeneficiaries’ interests

82

As noted in Section 3.2.2, Asset Owners
and investment managers are generally
required to act only in the interests of
those to whom they owe their duties or on
whose behalf they are acting and to avoid
conflicts of interest. Duties of this sortare relevant both to investors engaging in
instrumental IFSI and those engaging in
ultimate ends IFSI.

Instrumental IFSI
83

84

In the case of instrumental IFSI, theexample of Asset Owners who may needto ensure fair treatment for different
cohorts of beneficiaries in determining
whether and how to pursue sustainability
impact goals was touched on above. They
may need to satisfy themselves that inpursuing goals for the benefit of one setof beneficiaries they do not put undueemphasis on short-term financial returnat the expense of steps to secure longerterm value growth for beneficiaries whose
interests will only crystallise in the longterm, or vice versa.
Consider, for example, the position ofa pension scheme, with pensions inpayment, but also with members whowill not receive a pension for 30 or 40
years. An insurer’s position is potentiallysimilar, with policies already in payment
or maturing in the short-term and policies
under which payments will not be due for
decades. Those with long-term interests
are likely to want steady long-term growth(whether from increasing market value
or accumulated income or a mixture)and the concern of those with shorterterm interests is in the security of thepayments due to them. Such conflicts
must be addressed and resolved not only
in relation to strategic asset allocation andinvestment decisions, but also in relation
to stewardship and public policy-related
decisions because the anticipated benefit ofthose decisions may well not accrue to thesame beneficiaries as will bear any direct
and indirect costs51 of actions taken now.
85

In practice, these conflicts may be lessacute than might immediately appear,
because the interests of those members or
policyholders with shorter-term horizons
may, in fact, be provided for by investment
to a greater extent in fixed income or otherinvestments that may be less affected.
Asset Owners will also need to bear inmind that it may not be possible accurately
to predict when and how some financial
risks created by sustainability factors
could materialise. They could crystallise in
the short-term, or earlier than expected:‘If poorly managed, [the physical andtransition risks related to climate change]
could be the source of consumer harmand potentially a future financial crisis
stemming from financial losses and sudden

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
adjustments in asset values. COVID-19 has
demonstrated more than ever the needfor firms to be prepared for the rapid
crystallisation of global risks.’52 Further,the board of the investee enterpriseitself is first in line in seeking to balance
the interests of its current and future
shareholders and may therefore resist
stewardship efforts that it considers do not
strike this balance appropriately.

of instrumental IFSI; (b) rules explicitly
aimed at achieving environmental orsocial objectives; and (c) investment
arrangements set up specifically to achieveenvironmental or social goals.
(a)Instrumental IFSI

89

Section 3.2.3 described circumstances inwhich investors may conclude that they
are obliged to pursue sustainability impact
goals, including by using their investment
powers. It particularly highlighted two cases
based on current circumstances: where theuse of investment powers is part of a wider
move by investors into or out of a company
or sector which is aligned with bringing
about the sustainability impact sought andwhere an investor uses or threatens to use
its investment powers to strengthen its‘voice’ in stewardship activities.

Ultimate ends IFSI
86

Conflicts between cohorts and between theinterests of beneficiaries and third parties
could also arise where a sustainability
impact goal is pursued as an end in itself,
for example, for the good of society as awhole (ie ultimate ends IFSI) rather thanas a means to enhance the quality of longterm investment returns (ie instrumental
IFSI). However, where there is a clear legal
requirement or discretion to engage inultimate ends IFSI, the fact that this may
benefit non-beneficiaries is not likely to be
an actionable conflict of interest.

3.3

Asset Owners’ legal obligations anddiscretions to use investment powers
to pursue sustainability impact goals

87

The following section looks first at Asset
Owners’ legal obligations to use investment
powers to pursue sustainability impact
goals (Section 3.3.1) and second at available
discretions which would allow them to doso (Section 3.3.2).

3.3.1

Legal obligations to use investment
powers for IFSI

88

We have identified three categories wherea legal obligation may arise: (a) the case92

90

In Japan, the guidelines the Government
Pension Investment Fund (GPIF), thelargest asset owner in Japan, provide that‘investment of pension reserves must be
made for the benefit of participants andsafely and effectively from a long-term
perspective to ensure the Welfare Pension
Insurance’s stability into the future’53
and ‘based on the understanding thatsustainable growth of investee companies
and the market is necessary to increaselong-term gain by investing pension
reserves, a management institution
shall consider investment based on ESG(environmental, social, and governancematters).’54 These requirements provide
for investing for sustainability impact if
GPIF reasonably believes it will lead toachieving a higher investment return in the

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

middle to long term, even if it compromises
investment return in the short term.
(Sections 2.2.6; 2.2.12 Japan Report)(b)

Rules that explicitly aim at achieving
environmental or social goals

91

Legal systems in all jurisdictions prohibit
investment in certain anti-social activities.
Examples include anti-money launderingand anti-terrorist financing rules, antibribery rules, and bans on investment
in cluster munitions.55 All of these areconsistent with SDG 16 (peace, justice andstrong institutions), and while it would not
be usual to think of compliance with theseas IFSI, these prohibitions do have an impact
equivalent to a collective ‘ultimate ends IFSI’decision by investors to use their powers toachieve a reduction in these activities.

92

93

There are also cases where the law goes
further to impose, or potentially impose,
positive obligations to promote certain
beneficial social outcomes in or throughthe use of investment powers.
In Brazil, (a) all assets are subject to the‘social function of ownership’, and (b) all
contracts governed by and construed inaccordance with Brazilian law are subject
to the ‘social function of the contract.’
These principles56 provide for a duty
to respect and promote social justice,fair labour, best balance for the naturalenvironment and economic freedom.
(Section 1.4 et seq. Brazil Report)

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
94

In China, rules apply to insurers thatsupersede other duties and liabilities
under insurance policies and/or towards
shareholders that would amount to an
obligation in relation to ultimate ends IFSI.
These include:95• for equity investment, insurers may

only choose target companies that arein compliance with national industrial
policies, which exclude high energy
consumption and high pollution;57• for equity investment in the long-term

rental market, target projects must be of
positive economic and social benefit;58• for investment by means of collective

trusts, target projects or target
enterprises must be in compliancewith national general policies andindustrial policies;59• for debt investment, target projects

must be of positive social effect andin compliance with national and local
policies on industry, land, environmental
protection, energy saving and others; and60(c)

Investment arrangements set up
specifically to invest for sustainability
impact96

In some cases, an investment arrangement
such as a mutual fund or investment-based
life product will have been set up withthe objective of achieving sustainability
impact as well as a financial return.
Pension funds may also in some cases beable to offer investment options of thissort. In these cases, the Asset Owner will be
required to seek to meet the sustainability
impact objective in the way it manages theassociated assets. This would be a form ofultimate ends IFSI.

• insurers that are listed companies

have additional obligations, including
the duty to actively practice theconcept of green development, to add
ecological and environmental protection
requirements into strategy development
and corporate governance processes, toactively participate in the constructionof the ‘ecological civilization’,61 andto play an exemplary and leadingrole in pollution prevention, resource
conservation, and ecological protection.62(Section 2.4.9 China Report)

93

In South Africa, broad-based black
economic empowerment (‘B-BBEE’)legislation aims to promote the economic
empowerment of previously disadvantaged
South Africans, being citizens classified
as “African, Indian or Coloured”.63 While
many obligations under B-BBEE legislation
relate to public procurement by organsof state and state owned companies,
specific requirements apply to certain
Asset Owners.64 For example, pension fundtrustees have an obligation to consider
the need to promote the B-BBEE of those
providing services to the pension fund.65
Furthermore, when investing, pension
fund boards must consider any factor
which may materially affect sustainablelong-term performance. Regulatory
guidance states that evaluating thesustainability of an asset, includes but
is not limited to ‘the manner in which
B-BBEE is advanced.’66 (Section 2.3.17
South Africa Report)

97

98

The Asset Owner, or distributor of theinvestment arrangement, will generally berequired clearly to disclose its purpose andinvestment strategy so that beneficiaries
can select the product on an informed basis.
While there are variations between
jurisdictions products of this sort can,broadly, be offered as follows.

Pensions (including those provided by insurers)
99

There are instances in some jurisdictions
where it may be possible to offer pension
investment options which expressly involve
sustainability impact objectives.

100

However, in some jurisdictions, including
China and Japan, although there is no legal
prohibition, options of this sort would be
novel and it is unclear whether regulators
would be accommodating. Offering these
options is mostly confined to private sector
defined contribution schemes where
beneficiaries are given a choice of funds. It
is less likely to be practicable for public or
private sector defined benefit schemes.

101

102

Given the social importance of secure
retirement income, the extent to which
returns can be sacrificed to pursue otherobjectives is limited. The extent of thoselimitations and the way they are expressedvaries by jurisdiction.
In South Africa, provided that the pension
fund is likely to remain ‘financially sound’, itis permissible to have one or more ‘member
investment choice’ portfolios within apension fund that include(s) sustainability
impact objectives either as well as, or to someextent having priority over, financial return.
(Section 5.2.2 South Africa Report)

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
Regulated mutual funds
103

In all jurisdictions, subject to consumer
protection safeguards, it is possible to offer
regulated mutual funds which expressly
involve sustainability impact objectives.

104

Regulated mutual funds are premised on
the ability and freedom of beneficiaries toselect the fund they wish to invest in on
the basis of informed choice. In principle,
it is therefore usually possible to offer
investors regulated mutual funds with
objectives which include goals other thanfinancial return, including objectives thatshould take precedence over financial
return goals. However, most legal systems
require a product to be intended to achievesome level of financial return to qualify as
regulated mutual fund.

105

106

107

94

adopting an investment objective or
investment strategy that is geared towards
ultimate ends IFSI. Such investments areavailable to both retail and institutional
investors through financial institutions,asset management firms and credit unions,and require appropriate disclosures as toinvestment objectives, strategies and risks.
(Section 2.3.15 Canada Report)
108

Consumer protection rules which usually
apply to the marketing of mutual funds
could make it more challenging toincorporate some types of sustainability
impact objective, particularly where it isdifficult to measure impact in a meaningful
way, and so report on performance.
In Brazil, investment funds are allowed
to state in their by-laws that the portfolio
should be managed with a sustainability
impact objective. While financial return
must also be an objective, sustainability
impact can be prioritised. (Section 5.3
Brazil Report)
In Canada, mutual funds may be set
up for sustainability impact objectives.
Fundamental standard investment
restrictions (such as asset concentration
limits) under Canadian securities laws
in no way prohibit a mutual fund from109

In the EU, establishing a UCITS that
pursues a sustainability impact objective(either equal to or with priority overfinancial return) is neither prohibited nor
restricted under EU legislation, as longas the general obligations concerning a
UCITS’ investment policies are observed. A
management company must also use fair,correct and transparent pricing models
and valuation systems which may prove
complex if measuring sustainability impact
is difficult. Guidance in some jurisdictions
seeks to make clear that environmental orsocial objectives for UCITS are permitted.
For example, guidance from the UK
Financial Conduct Authority on the UK
UCITS regime, which is based on that in
the EU, states that: ‘Sometimes funds set
out non-financial objectives, for example
environmental or social objectives, or statethat they are aiming to achieve a nonfinancial return. We expect, if a fund hassuch objectives, that it will set them out inits prospectus and its KIID/KID’. (Section
2.3.17 EU Report, Section 2.3.20 UK Report)
In France, AMF rules and guidance havesince 2007 acknowledged the possibility ofusing non-financial criteria in the processof selecting financial instruments forinvestment by French funds. In addition,other AMF guidance has long provided
for disclosure requirements associatedwith socially responsible funds (referred
to as ‘fonds ISR’). The growing numberof Greenfin-certified funds reflects thecreation of funds on the French market
that pursue IFSI. The Greenfin certification
is based on financial managementtransparency and environmental impact
indicators. It is limited to certified funds
that genuinely finance activities withmeasurable environmental benefits.
(Sections 2.3.13; 5.3.2 France Report)
110

In the US, mutual funds can be set
up with sustainability impact objectives.
There must be appropriate disclosures in
the fund’s prospectus about the fund’s
strategy and attendant risks. (Section 5.3.1
US Report)

Non-pensions life insurance
111

In a number of jurisdictions, subject toconsumer protection safeguards, it would
be possible to offer a least some typesof life insurance investment productwhich involve sustainability impact
goals, including in priority to financial
return. However, in some jurisdictions,although there is no legal prohibition onsuch products, they may be regarded as
novel and could meet with hesitancy from
regulators and other practical difficulties.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
112

113

114

95

In the Netherlands, life insurers
are permitted to create products withan investment objective to invest forsustainability impact, provided thatthe applicable consumer protection
requirements, including product design
and marketing requirements, are satisfied.
Regulation applicable to certain typesof life insurance products specificallycontemplates products which ‘target
specific environmental or social objectives’.
Policy terms and marketing materials
should address the prioritisation between
the objectives of financial return andsustainability impact. (Section 5.1.9
Netherlands Report)
In the UK, life insurers can offer
policies with sustainability impact
objectives, provided that applicableconsumer protection requirements are
satisfied. The regulatory regime for certain
types of life insurance product specificallycontemplates products which ‘target
specific environmental or social objectives’.
(Section 5.4.1 UK Report)
In most cases it is also, in principle,
possible to amend the terms of existing
investment arrangements to incorporate
sustainability impact objectives, where
the inclusion of such an express objectivein that type of product is permitted bylaw. However, commonly, amendment
would require the consent of a majority(or even all) beneficiaries and potentiallyregulatory consent. Pension fund objectives
can sometimes be amended without
beneficiary consent. However, several
jurisdictions have indicated that it may bechallenging for a pension scheme trustee
or manager to reconcile unilaterally
amending a pension scheme with theirlegal duties.67
3.3.2

Discretion to use investment powers to
pursue sustainability impact goals

115

In every jurisdiction surveyed, some types
of Asset Owner have a degree of discretion
to use their investment powers to pursue
sustainability impact goals. We consider
in what follows four possible categories
of legal discretion: (a) in the context of
instrumental IFSI; (b) basic discretions
available (expressly or inherently) for
particular types of Asset Owner; (c)where pursuing sustainability impact
goals is permitted based on beneficiaries’
views; and (d) where duties relating tobeneficiaries’ interests extend beyond theirfinancial interests.

116

117

The first would be for the purpose ofdischarging duties to seek to secure afinancial return. However, discretions
within (b) to (d) would operate in parallelwith seeking to meet financial returnobjectives. They would therefore represent
a form of ultimate ends IFSI. In mostcases, unless an individual investment
arrangement permits something broader,they would only be permitted provided
that the relevant Asset Owner hasprioritised its duty to seek to meet its
financial investment objectives.
As discussed at Section 3.4.2(d) above, mostAsset Owners and investment managers
are subject to a duty to act exclusively in
the interests of the person or persons towhom they owe their duties. In some cases

and in some jurisdictions this duty means
it is difficult to make decisions that are
motivated by objectives that will deliver
benefits more widely. However, where
there is a clear legal discretion to engage
in ultimate ends IFSI it is unlikely that thiswould be regarded in law as giving rise toa conflict of interest merely because nonbeneficiaries may benefit.
(a)Instrumental IFSI

118

As mentioned in Section 3.2.3 it is possible
to imagine circumstances in which an
Asset Owner is not legally obliged toconsider engaging in instrumental IFSI but
might conclude that it has the discretion
to use investment powers to do so. An
example might be where it has identified
particular sustainability improvementsthat are likely to flow through to improved
financial returns, leading it to invest in andwork with investee enterprises to achieve
those sustainability improvements so as toachieve value growth.

119

In Brazil, a pension fund could exercise
its investment powers for sustainability
impact, provided its legal and regulatory
obligations (provisions of the by-laws,
regulations, investment policies andapplicable contracts) are fulfilled,68 if
it can properly conclude that such aninvestment will protect the portfolio’s
net value in the long term (ie the primary
pursuit of financial return in order tomeet EFPC’s actuarial duties is observed)
and fulfil the social function of ownershipand of contract provided in the Federal
Constitution and in the Civil Code. (Section
5.2.3 et seq. Brazil Report)

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
120

121

96

In France, the AGIRC-ARRCO federation
and affiliated pension institutions do
not have any specific direct duties toindividuals that are beneficiaries of theplan. They therefore are not required toassess whether their investment decisions
conflict with the beneficiaries’ interest,
but rather only make sure that overall,the integration of Sustainability Impact ininvestment decisions is not inconsistent
with meeting the plan’s portfolio’s
financial return and does not endanger
the plan’s financial sustainability. This
removes any possible perceived increased
liability risk associated with investment
decisions that could be construed as not
being made in the “best” interest of
beneficiaries. There is also clearer potentialalignment between IFSI and a plan that has
to foster long-term “interprofessional andintergenerational solidarity”, rather thana plan that has to assess its investment
decisions directly in light of specificbeneficiaries’ best interest. (Section 2.2.31
France Report)
In the Netherlands, a key requirement
under the Dutch Pensions Act (Pensioenwet(DPA)) is that a pension fund must set
its investment policy and invest its
assets in the interest of its participants,
acting in accordance with the so-called‘prudent person rule’. The courts haveestablished that the prudent person rule
gives pension funds the freedom to invest
within the parameters set by the DPA
and the Financial Assessment Frameworkfor Pension Funds (Besluit financieel
toetsingskader pensioenfondsen (FTK Decree)).
This includes the requirement to adopt a

longer-term strategic investment policy inline with the fund’s objectives and policy
principles, including its attitude to risk, aspart of which the fund must also consider
the environment, the climate, humanrights and social relationships (Article
18 FTK Decree). (Sections 2.1.7; 2.1.22
Netherlands Report)(b)Discretion to use investment powers for
ultimate ends IFSI as between types ofAsset Owner

122

General insurers, and life insurers
investing funds that are not linked to theirpolicyholders’ policy returns, generally
have the most flexibility to use theirinvestment powers to engage in ultimate
ends IFSI. This is because, provided they
make sufficient returns to pay policyholder
claims and meet regulatory requirements(for example, prudential requirements
to maintain certain levels of capital orin relation to the asset classes in which
they may invest69), they are typicallyaccountable to shareholders, rather thanpolicyholders, for investment returns. Thismay mean that they have greater scope toinvest with the long-term success of theinsurer in mind, including for example,
taking account of reputational benefits ofsustainable business practices and, in somejurisdictions, with appropriate regard to‘stakeholders’ more broadly.

123

By contrast, pension funds and insurers
investing funds they manage in connection
with investment-based life insurance
contracts will usually have less flexibility
to use investment powers to engage
in ultimate ends IFSI, at least where

it could damage financial returns forbeneficiaries. There is a broad variety of
insurance policies available in the various
jurisdictions, and the particular featuresof different policy types, and the basis onwhich they were marketed, will affect thelegal analysis. Many will have prescriptive
terms regarding investment objectives
or strategy which may limit whatever
flexibility there might otherwise havebeen to use investment powers to pursue
sustainability impact goals.
124

Regulated mutual funds generally have theleast flexibility due to typically prescriptive
investment objectives and policies,
supported by strong consumer protection
requirements. These leave asset owners withlittle to no flexibility to engage in ultimate
ends ISFI where this is not specificallyprovided for in the product terms (as towhich see Section 3.3.1(c) above).

125

The extent of the discretion available varies
significantly by jurisdiction and Asset
Owner and so we provide some examples ofthe differences in approach below.

126

In Canada, as regards pension funds,
the Trustee Act (Manitoba) explicitly statesthat non-financial criteria may be used
‘to formulate an investment policy or to
make an investment decision’; there isa similar provision in the Pension Benefits
Act (Manitoba). As regards insurers, theSupreme Court of Canada, on the subjectof all corporate directors, has stated in its
decision in BCE Inc. v 1976 Debentureholders
that directors are under a duty to ‘actin the best interests of the corporation
viewed as a good corporate citizen’ (emphasis

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
added) and it has been argued that such anunderstanding ‘furthers the broader social
purpose of fiduciary duties by requiring
fiduciaries not to undertake unethicalactions that would shake public confidence
and trust in fiduciaries and the services
they provide.’70 (Sections 2.2.23; 2.4.11
Canada Report)
127

128

97

In France, as regards mutual funds andinsurers taking the form of companies,
the French Civil Code was amended in2019 by the PACTE law to state thatcompanies must be managed in theirown ‘corporate interests’ (as opposedto those of their shareholders) and ‘bytaking into consideration the “social andenvironmental issues” related to theiroperation.’ The PACTE law also amended
French corporate law to provide that
directors on French companies’ corporate
and management boards must take into
account ‘social and environmental issues’
when determining the orientation of
the company’s business and supervising
how it is carried out. Therefore, French
corporate law now explicitly provides fora duty of directors to consider ‘social andenvironmental issues’ when operating thecompany. (Section 2.4.8(c) France Report)
The fonds de réserve pour les retraites (FRR)
is responsible for investing with a viewto creating reserves for the French basic
pension system. The FRR considers
that as a public investor and ‘vector forintergenerational solidarity’, it mustfactor ESG principles into the investment
management of its assets. In its 2013-2017
responsible investment strategy, the FRR
expressly stated that, as part of ‘a new

approach for the FRR’, it ‘will also help tofinance companies the corporate missionof which is to preserve the environmentor are beneficial to society.’ The FRR has
implemented an ambitious policy aimed
at reducing its portfolio’s CO2 emissions
through low carbon management. In thelatest version of its responsible investment
strategy, investment policy guidelines, the
FRR states that it will ‘continue to rely on
its value as a long-term public investor
to take into account and measure theimpact of its investments while seeking
to safeguard its enduring objective offinancial performance.’ Under that policy,
to ‘develop its investments’ responsible
dimension’, the FRR notes that it willseek to ‘pursue impact’ and will ‘define
indicators and tools to measure its impact’.
(Section 5.2.5 France Report)
129

130

In the Netherlands, as regards pensions
a large number of Dutch pension funds
have agreed to cooperate to create a moresustainable society by preventing or
tackling negative consequences for society
and the environment of investments bypension funds under the Dutch Pension
Funds Agreement on Responsible
Investment (2018). (Section 2.1.35
Netherlands Report)
As regards insurance companies, the Dutch
Corporate Governance Code requires the
management board of companies whose
shares are listed on a regulated market or
a comparable system to focus on longterm value creation for the company andits affiliated enterprises. In doing so, themanagement board should formulate astrategy that reflects this focus. Whendeveloping the strategy, attention shouldbe paid to, among other things, theinterests of the stakeholders and anyother aspect relevant to the company
and its affiliated enterprise, such as theenvironment, social and employee-related
matters. (Section 2.1.67 Netherlands
Report)131

In South Africa, pension fund boards’
general legal duties and powers permit
significant flexibility to use investment
powers for sustainability impact provided
that the fund remains financially sound,and the board takes all reasonable steps
to ensure that the interests of the fund’s
members are protected in terms of thefund’s rules and applicable legislation. This
leaves pension decision-makers free to use
investment powers for sustainability impact
rather than, or in addition to, risk-adjusted
returns as long as those requirements are
met. The position is similar for insurers who
have flexibility to use investment powers forsustainability impact subject to requirements
to maintain their business in financiallysound condition and to meet regulatory
requirements, such as capital requirements.
(Section 2.3.36 South Africa Report)(c)Discretion to engage in ultimate ends IFSI
based on beneficiaries’ views

132

Other than investment products expressly
set up to pursue sustainability impact
objectives, in many jurisdictions there
are examples where there is some scope
for Asset Owners to take account ofbeneficiaries’ views about pursuing IFSI.
Generally, beneficiaries’ views may besignificant as to whether an Asset Owner

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
can pursue sustainability objectives, but
not so as to override Asset Owners’ duties
to pursue financial returns. So, some types
of Asset Owner in some jurisdictions may
have discretion to engage in ultimate ends
IFSI based on beneficiaries’ views, but
only to the extent that financial returnobjectives will permit this.
133

134

98

Asset Owners in a number of jurisdictions
surveyed do undertake consultation
exercises to ascertain beneficiary views.
How far it is safe from a legal perspective torely on these will be a matter of judgement
which may need to take account of various
factors such as the degree of discretion
the Asset Owner is considering exercising(for example, whether it could create amaterial risk of beneficiaries experiencing
worse financial outcomes, or merely thatsustainability can be one of the lenses
through which investments are considered),
the percentage of beneficiaries whose views
have been sought and who have responded,and the degree of consistency in the views
they have expressed.
In Japan, decision-makers of certain
types of pension funds (mutual aid
associations and DB Plans in particular)
are permitted by their ‘mandatary’s
duty’ (a duty of care and loyalty similar
to duties in common law countries) toreflect beneficiaries’ views on the useof investment powers for sustainability
impact in the objective of the portfolio,
even to the extent of making financial
return a secondary objective if thebeneficiaries’ view is so clear as to support
that, although this is regarded as unlikely
in practice. (Section 2.2.16(c) Japan Report)

135

136

137

In the UK, there is a well-supported
view that pension fund trustees can, tosome extent, consider ‘non-financial’
factors on the basis of beneficiaries’ views.
Beneficiaries’ views could conceivably
include their preferences to haveinvestment powers used for sustainability
impact. Regulatory guidance provides
that non-financial factors may be taken
into account where: a) pension fundtrustees have good reason to think that
beneficiaries would share the concern;and b) the decision does not involve a riskof significant financial detriment. There
are important questions as to how these
conditions would operate in practice, forexample, how trustees should determine
what is an acceptable level of detrimentand what would amount to a ‘good
reason to think’. The UK’s FCA has also
recently introduced similar guidance forlife insurers in relation to policies held byindividuals. (Sections 2.2.44-48; 2.4.37-40
UK Report)
In some jurisdictions, relevant regulators
seem to consider that beneficiaries’ desires
to pursue objectives other than financial
return should be addressed by offering‘choice’ products which beneficiaries canselect, rather than, or in addition to, trying
to ascertain and reflect these preferences
in more general investment arrangements.
In Australia, regulatory guidance forAustralian pension funds provides thatconsideration of beneficiaries’ views,‘may result in an [APRA-regulated trustee]offering an “ethical” investment option tobeneficiaries’. (Section 2.2.33
Australia Report)

138

In France, as from 1 January 2022,
unit-linked insurance contracts will haveto include at least one underlying asset foreach of three categories of ESG investments
and insurance companies will be required
to inform their clients of the percentage
of underlying assets within each contract
meeting these conditions, before theydecide to invest. The aim of this provision
is to better inform clients of the possibilityof investing in ESG assets. French law
applicable to operators of occupational
pension plans expressly allows them totake account of beneficiaries’ preferences
inasmuch as beneficiaries must be offered
the possibility of selecting at least one
alternative asset allocation, including, foremployer-sponsored plans, an allocation
allowing them to invest in social impact
funds (fonds solidaires) that invest in specificsocial impact companies (entreprises
solidaires d’utilité sociale). (Sections 2.2.21;
2.4.8(d) France Report)(d)Consideration of beneficiaries’ interests
beyond their financial interests in theoutcome of the relevant investment
arrangement

139

As noted above, legal regimes tend toconverge around legal standards requiring
portfolios to be managed in the ‘interests’of beneficiaries. This raises the questionof whether those ‘interests’ are restricted
to their financial interest in the outcomeof the relevant arrangement or include a
broader set of beneficiary interests, suchas living in a habitable environment, theirown health, quality of life and wellbeing
and that of their families.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
140

141

142

143

99

In at least some cases, directors of
insurance companies, discussed at Section
3.3.2(b) above, are likely to have thisfreedom since the interests of a company
do not generally reduce exclusively tomonetary outcomes.
However, more broadly, in most of thejurisdictions surveyed, these wider
interests have generally not been
held, as a legal matter, to be a relevant
consideration for Asset Owners in theirinvestment decisions. So, while Asset
Owners are usually required to invest in
the ‘best interests’ of their beneficiaries,
those interests are commonly limited tothe beneficiaries’ financial interests inthe outcome of the relevant investment
arrangement. However, there are some
limited exceptions.
In Canada, based on rulings of theSupreme Court of Canada, it has beensuggested, in relation to pension funds,
the duty of loyalty requires the fiduciary
to consider both the pecuniary interestsof the beneficiary and their ‘status as a
responsible member of society’.71 (Section
8.1.3 Canada Report)
In the UK, the Law Commission
expressed the view in its 2017 report on
pension funds and social investment thattrustees cannot simply refuse to takeaccount of ‘non-financial factors’ that
may affect members in all circumstances,
however serious the potential non-financial
harm to their members because to do sowould amount to an impermissible fetteron the trustees’ discretion. However, the
Law Commission thought it would be rare

for trustees to reach the conclusion thatthey must take account of non-financial
factors for this reason. (Sections 2.2.38-40
UK Report)
3.4

Asset Owners’ use of stewardship
activities to pursue sustainability
impact goals

144

The goal of stewardship is generally tosecure some sort of change in behaviour on
the part of the investee enterprise so that,
where it directly or indirectly concerns
sustainability factors, it could wellconstitute a form of IFSI.

145

The following section starts by making
some preliminary observations concerning
Asset Owner engagement in stewardship(Section 3.4.1). It then looks at Asset
Owners’ legal obligations and discretions
to engage in stewardship to achievesustainability impact goals (Section 3.4.2).

146

The position in relation to stewardshipbroadly resembles that for the use ofinvestment powers. However, the practicalcircumstances in which stewardship could
be required or permitted are likely todiffer, for example, because stewardshipdoes not have the same implications for
portfolio composition and value as using
investment powers.

3.4.1

Preliminary observations on Asset
Owners’ engagement in stewardship

147

Before outlining our findings in relation
to engagement in stewardship, it is worth
making some general points concerning(a) the growth in investor, policymaker
and wider attention to stewardship; (b) the
factors that investors may need to take into

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

account in their decisions on stewardship;and (c) the role of collective action.
(a)Growing attention to stewardship among
investors, policymakers and more widely

148

Irrespective of legal obligations to doso, there is no doubt that in many
jurisdictions (such as the EU, South Africa
and the UK) there is both governmental
and industry momentum behind anincreasingly active stewardship approach,with sustainability as a prominent feature,
while in others the industry may be aheadof government in advocating for thisapproach. In some cases, this is reflectedin legislation. For example, measures, suchas the EU SSRD, aim to discourage undue
focus on short-term returns and instead
foster long-term shareholder engagement.72
This has also resulted in the developmentof stewardship codes.

149

In nine out of the jurisdictions covered,
there is some form of ‘stewardship code’
that describes good or best practice forengagement with investee companies. The
jurisdictions which do not have one are
China and France. In the EU, there is an
EU-wide stewardship code published by
the European Fund and Asset Management
Association (EFAMA), but stewardshipcodes have been adopted in some of its
member states. The precise legal status ofthese codes differs between jurisdictions,but they are generally maintained either
by industry bodies, or at least bodies thatare either wholly or largely distinct fromgovernment. Adherence to the codes isvoluntary in each case, and there are
varying levels of adoption between codes.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSIIn a number of jurisdictions (such as theEU, Japan, the Netherlands, South Africa
and the UK) adoption is on a ‘comply or
explain’ basis. In some cases, there isa degree of official encouragement forinvestors to adhere to the relevant code.
For example, in the UK the FCA requires
investment managers to state the nature of
their compliance with the UK Stewardship
Code. As noted in Part B.4, Box 5, while
there are differences between jurisdictions,where an investor is accused of breachingits duties, courts would be likely to takeaccount of established industry practice inassessing whether the investor has acted ina manner consistent with the relevant legal
standard. In some cases, a stewardshipcode, or associated industry guidancedeveloped in connection with it, could bereferenced in assessing that.
150

151

100

The content and level of detail of the
stewardship codes examined in preparing
this report and associated guidance also
varies between jurisdictions. However,the codes typically relate the purpose of
stewardship to long-term financial return
to beneficiaries and often recognise that
this is likely to mean that sustainability
risks should be a key focus of engagement
activities and that wider benefits flow fromthis (see, for example, the UK stewardshipcode below).
All the codes surveyed also draw attention
to the benefits of collaboration with otherinvestors, although with differing levels ofemphasis or focus. For example, in Brazil,
Canada, the EU, South Africa and the UK,
collaborative engagement is established
as a central principle. In Australia, theNetherlands and Japan, the codes include
collective or collaborative engagement insecondary guidance but it is not presented
as a key principle.
152

153

154

a move from an ‘apply or explain’ regime
to an ‘apply and explain’ regime, andincludes among its objectives, ‘to build
a common awareness of stewardshipand responsible investment throughout
the investment value chain and acrossall asset classes as universally relevant(shifting away from perceptions oflimited applicability to listed equity).’
The revised draft recommends that,‘investment arrangements and activities
demonstrate the acceptance of ownership
responsibilities (where applicable) andenable diligent discharge of stewardshipduties through purposeful engagement andvoting.’ It also sets out eight draft practicerecommendations for implementation
and reporting on the diligent discharge of
stewardship activities.74 (Section 1.15.2-3
South Africa Report)

In Australia, many of the country’s
largest Asset Owners are signatories to
the Australian Council of Superannuation
Investors Stewardship Code. The code
requires signatories to report publicly
on stewardship activities, including
collaborative engagement practices. The
code states that stewardship benefits
companies, asset owners, beneficiaries
and the economy as a whole. (Section 3.5.1
Australia Report)
In the Netherlands, the Dutch
Stewardship Code provides eleven nonbinding principles for stewardship by asset
owners and investment managers towards
Dutch listed investee companies that haveto be complied with on a ‘comply or explain’basis. The first requires them to have a
stewardship policy aimed at preserving andenhancing value for their beneficiaries and/or clients and to promote long-term value
creation at Dutch listed investee companies.
Monitoring investee companies on amongst
others social and environmental impact isalso one of the principles under the Dutch
Stewardship Code. (Sections 3.2.14 et. seq.
Netherlands Report)
In South Africa, the voluntary Codefor Responsible Investing in South Africa(CRISA) sets out five key principles on how
institutional investors should execute
investment analysis and investment
activities. A revised draft CRISA, publishedfor comment in November 2020,73 proposes

155

156

In the UK, the Stewardship Code2020 set outs principles for the use of
stewardship to ‘create long-term value
for clients and beneficiaries leading tosustainable benefits for the economy,
the environment and society.’75 The code
includes a requirement for signatories toreport on how they have, where necessary,participated in collaborative engagement to
influence issuers.76 (Section 1.11; 3.1.9-12
UK Report)
In the US, the Investor StewardshipGroup (ISG) is an investor-led effort that
includes over 60 US-based institutional
investors and global asset managers,
including some of the most significant
pension funds and mutual funds. The
ISG began as an initiative to establish
a framework of basic investment

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
stewardship and corporate governancestandards for both investors andcompanies. The ISG put together a set ofstewardship principles for institutional
investors and governance principles
for US public companies. The ISG seekscommitments from its institutional
investor members to seek to implement
the ISG’s stewardship principles, in amanner appropriate for the relevant
investor. (Section 3.1.7 US Report)(b)Impact, cost and expense of stewardship
activities

157

As discussed in Part A.1.2.3, particularly
where investment is through publicmarkets, stewardship may often be amore practical and effective way to pursue
sustainability impact goals than the use ofinvestment powers. However, stewardshipis not free of cost. Pursuing sustainability
impact goals involves seeking to achievechanges in investee enterprise behaviour.
It is possible that these changes could havesignificant financial consequences, positiveor negative, for the company concerned
and therefore, potentially, the Asset
Owner, over various time periods. These
potential consequences therefore need tobe taken into account in the Asset Owner’s
decisions, so as to ensure fair treatment
between different cohorts of beneficiaries(see Sections 3.2.3 and 3.4.4(b) above). Most
forms of stewardship also involve somelevel of expense. How much depends onthe form of stewardship. In some cases,
it may be relatively modest. However,maintaining a team that is capable ofdeep engagement can be materially more

101

expensive. Again, an Asset Owner would
need to take account of these expenses in
its stewardship-related decisions.
(c)Collective action and stewardship

158

Some Asset Owners may be sufficiently
influential for their own stewardship
activities to have a sufficient chance of
success to justify their cost. However,generally more formal collaboration is
likely to be key both for stewardship
activities to be successful and to limit thecosts (eg through the sharing of applicable
expertise and research). Even large
Asset Owners typically own only a small
percentage of financial instruments issued
by a particular enterprise. Therefore,
where Asset Owners work alongside otherinvestors to influence investee companies,
the likelihood of achieving their objective
is increased, and the likelihood of successwill be an important considerationin deciding whether to incur cost in
stewardship activity. There is already asignificant number of these initiatives atboth national and international level (seePart B.2, Box 2).

159

Since Asset Owners frequently delegate
stewardship activities to their investment
managers, the extent to which stewardshipis undertaken and to what ends depends, inprinciple at least, on what delegating Asset
Owners require of their managers. The
legal position of investment managers in
relation to IFSI is considered at Section 3.6
below. However, delegation to investment
managers can have a similar aggregating
effect to collective stewardship activity(for example, in terms of potential for

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

increased effectiveness and reduced
aggregate cost) since the manager generally
takes a single stewardship approach inrespect of all assets under management.
160

The legal restrictions, discussed at Section
3.2.4(c), that need to be taken into
account where investors engage incollective action are particularly relevant
to stewardship activity.

161

In Japan, the Stewardship Code, towhich many Asset Owners are signatories,
ties (collective) engagement to longterm financial return by stating that ‘aninstitutional investor should increase
mid- to long-term investment return […]by prompting increases in the corporate
value and sustainable growth of aninvestee company through […] constructive“purposeful dialogue” (engagement) basedon consideration of sustainability (mid- tolong-term sustainability including ESG
elements).’77 The code also states that,‘when an institutional investor engages aninvestee enterprise, it may do so alone, but
if necessary, it could be beneficial to engage
in collaboration with other institutional
investors (collective engagement).’78(Sections 3.1.3; 3.3.3 Japan Report)

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM

3.4.2 Legal obligations to pursue
sustainability impact goals throughstewardship

ANNEXES

162

GLOSSARY

A legal obligation to engage in stewardshipmay arise in the context of (a) instrumental
IFSI; (b) legal rules that explicitly aim atachieving environmental or social goals;
and (c) investment arrangements set up
specifically to achieve environmental orsocial goals (of a sort considered at Section

REFERENCES

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
2.3.1(c) above, subject to the terms of theparticular arrangement. The following
comments briefly on (a) and (b).
(a)

Instrumental IFSI in pursuit of financial
goals

163

Where an Asset Owner has concluded that
one or more sustainability factors create
financial risks for its portfolio that may
prevent it from achieving its financial
objectives within the relevant time frame,
stewardship activity (alone or as part ofa larger group of similarly affected asset
owners) is something that it must at leastconsider.79 Having done so, taking accountof the factors outlined at Section 3.2.3, an
Asset Owner may also conclude that it hasa legal obligation to act.

164

In Japan, as regards the Government
Pension Investment Fund, the mid-termgoals issued by the Ministry of Health,Labour and Welfare expressly refer to therole of stewardship stating that ‘to gain longterm benefit for the interest of participants,
GPIF shall increase its stewardship activities
bearing in mind the effect to the market.’80(Section 2.2.6. Japan Report)(b)Specific legal requirements for ultimate
ends IFSI

165

We have identified one case in which there
is a specific requirement on Asset Owners
to undertake a form of IFSI through theirstewardship activities.

166

102

In China, Chinese law imposes
an obligation on Chinese insurers tocomply with legislation which pursues
socially desirable goals when conducting
stewardship (see Section 3.4.1 b) above).

They would not in principle be able toexercise their engagement powers incontravention of such rules. (Sections 3.4.1;
3.4.3. China Report)(a)Instrumental IFSI

170

We gave an example in Section 3.3.2(a) of
where an investor may have a discretion
rather than an obligation to engage ininstrumental ISFI and inherent in thatexample would be the use of stewardshipto influence investee enterprises toimprove their performance in relation to
the targeted sustainability factors in order
to increase value.

3.4.3 Discretion to pursue sustainability
impact goals through stewardship
167

168

169

In every jurisdiction surveyed, some types
of Asset Owner have a degree of discretion
to engage in stewardship to pursue
sustainability impact goals. The sorts of
discretion correspond with those available
where investors are using theirinvestment powers.

171

Discretion in the context of instrumental
IFSI would be exercisable for the purposeof seeking to secure a financial return (see(a) below). Others would operate in parallelwith seeking to meet financial returnobjectives (see (b) below). They would
therefore represent a form of ultimate ends
IFSI and, unless an individual investment
arrangement permits something broader,would be subject to the relevant Asset
Owner prioritising its duty to seek to meetits financial investment objectives.
Our comments at Section 3.3.2, on Asset
Owners’ duties to act in the interests of theperson or persons on whose behalf they
exercise their powers or to whom they owe
their duties, apply similarly here.

In Australia, where an APRA-regulated
trustee or life insurer forms the viewthat the value of the investment may be
improved by positive sustainability impacts
attributed to the business of the relevant
enterprise, stewardship activities may be
aimed at promoting those improvements.
It may also be possible for regulated
mutual funds81 to engage in stewardship
activities in relation to portfolio
constituents designed to achieve positive
and/or reduce negative sustainability
impacts if those stewardship activities
are reasonably expected to contribute
positively and directly or indirectly to thegrowth in value of the applicable portfolio
constituent. (Section 3.2.2 Australia Report)(b)Ultimate ends IFSI

172

Section 3.3.2 above looked at circumstanceswhere Asset Owners may have a discretion
to use investment powers for ultimate ends
IFSI. As a general matter where they do,they will also be permitted to engage in
stewardship to similar ends. As the costs
and risks of stewardship may be lower
than for the use of investment powers andthe likelihood of achieving aa assessable
sustainability impact may be higher, there

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
173

174

103

may be greater scope for the investors
concerned to engage in stewardship thanto use their investment powers.

3.5

Asset owners’ use of public policy
engagement to pursue sustainability
impactIn Australia, stewardship forsustainability impact is permitted where it
will support the APRA-regulated trustee’s
member engagement strategies aimed
at attracting and retaining members toensure the long-term viability of the fund,even where it is not expected to contributedirectly to investment return. For
example, where an investee enterprise’s
activities may have negative sustainability
impacts that draws adverse publicity
to a trust which has positioned itself as‘socially responsible’ or a ‘good corporate
citizen’, one option available to an APRAregulated trustee may be to engage withthe company to seek to persuade themto reduce their negative sustainability
impact.82 (Section 3.2.2 Australia Report)

175

The following section looks at Asset
Owners’ legal obligations and discretions
to undertake policy engagement to achievesustainability impact goals.

In the Netherlands, the vast majorityof Dutch pension funds have developed
an ESG investment policy which covers
stewardship activities as well as the use of
powers of investment and divestment. For
example, both ABP (Stichting Pensioenfonds
ABP) and PMT (Stichting Pensioenfonds Metaal
en Techniek) have included in their respective
stewardship policies that they will actively
use their voting and meeting/discussion
rights to enter into conversation withcompanies in which they invest, to influence
the companies’ strategy and impact on thepolicy and behaviour of such companies.
(Sections 3.2.3-5 Netherlands Report)

177

In every jurisdiction surveyed, some types
of Asset Owner have a degree of discretionto undertake policy engagement to pursue
sustainability impact goals.

178

Obligations and discretions available inthe context of instrumental IFSI would be
for the purpose of discharging duties inseeking to achieve a financial return (seeSection 3.5.1 below). Others, more likely
discretions, would operate in parallel withseeking to meet financial return objectives(see Section 3.5.2 below). Exercising these
discretions would therefore represent aform of ultimate ends IFSI.

176

179

Before doing so, it is important to notethat each jurisdiction will have its own
tolerance for private organisations
becoming involved in policy advocacy,
particularly where a policy may
be politically divisive. So, while inmany jurisdictions Asset Owners are(individually, or through industry
groups) already involved in public policy
engagement relevant to sustainability
impact,83 and in some jurisdictions
relevant regulators have endorsed this,84
in others there are those who question its
appropriateness.

Our comments at Section 3.3.2, paragraph[135] (in the context of discretions toengage in ultimate ends IFSI when using

investment powers) on Asset Owners’
duties to act in the interests of the person
or persons on whose behalf they exercise
their powers or to whom they owe theirduties, apply similarly here.
3.5.1

Instrumental IFSI in pursuit offinancial goals

180

As with investment powers andstewardship, once an Asset Owner has
concluded that its ability to achieve its
financial objectives over the relevanttime period is likely to be threatened by asustainability risk, it will be legally obliged
to consider what options are available tomitigate the risk, which would include
the possibility of policy engagement, andact accordingly. In considering policy
engagement, Asset Owners would need tobe satisfied, on reasonable grounds, that
there is a reasonable prospect that they
will be able to influence policy outcomes
and that those policy outcomes will havesustainability impacts that support therealisation of their financial objectives.
As for stewardship, cost and effectivenessconsiderations suggest that collaboration
with other Asset Owners is likely to be
desirable. Many national and international
industry initiatives involve public policy
engagement and trade associations often
engage in such activities on behalf of theirmembers to consolidate their voices.

181

In Australia, APRA-regulated trustees
can engage in public policy work forsustainability impact where to do so is
aimed at promoting the superannuation
fund’s financial returns, including
minimising risks.85 For example, an APRA-FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
regulated trustee’s assessment may be thatthe government’s policy position (or lackof a policy position) is adversely impacting,or is likely to adversely impact, returnsof the superannuation fund, or returnsof asset sectors that the APRA-regulated
trustee invests in (or would invest in).
Before commencing public policy work,
responsible entities are required, under
their duty of care and diligence, to consider
and evaluate the costs, benefits, potential
risks and the likelihood of potential
positive and negative outcomes to themembers of the scheme. (Section 3.4.3
Australia Report)
3.5.2 Ultimate ends IFSI
182

183

104

As a general matter, we would expectthat investors which are of a type, or ina situation, where they have a discretion
to use stewardship powers for ultimate
ends IFSI, would be similarly entitled touse public policy engagement. In practice
however, because this sort of engagement
is not an ‘ordinary course’ activity
for investors, in contrast to the use ofinvestment and stewardship powers, theinvolvement of investors in this activity(except indirectly, through the activityof industry associations) does vary fromjurisdiction to jurisdiction.
As with discretionary stewardship activity
for ultimate ends IFSI, an Asset Owner
that was otherwise permitted to use public
policy engagement for this purpose would
need to be satisfied that the public policy
outcome it was seeking (and the costs ofthe public policy engagement) would not
be detrimental in terms of realising
its financial objectives.

184

185

In Australia, a life insurer, perhaps ona co-ordinated basis with the AustralianFinancial Services Council (FSC) as therelevant industry body, would be permitted
to use public policy engagement aimed atachieving a positive sustainability impact,
provided the outcome sought was notinconsistent with: (a) promoting financial
returns from the insurance company’s
investment portfolio (including minimisingrisks); and (b) in relation to investmentlinked policies, the objectives set out inthe terms of the policy and any disclosure
documents issued to investors. (Section
4.4.3 Australia Report)

3.6.1

The role of investment managers and
IFSI

188

The key sources of investment managers’
legal duties and powers are generally a
combination of:• the terms of their contractual

relationship with the Asset Owner,
normally set out in an investment
management agreement;• duties of care arising either under the

In the UK, insurance companies canundertake public policy engagement forsustainability impact if their directors
conclude that this will promote thesuccess of the company. The costs ofthis would ordinarily need to be borneby shareholders’ funds, and long-term
insurers would need to be satisfied thatthe objectives they were pursuing would
not conflict with the interests of theirpolicyholders. (Section 4.4 UK Report)

3.6

Investment managers and IFSI

186

Given the significant extent to which Asset
Owners outsource management of theirportfolios, the role of investment managers
is critical in the extent to which assets arelikely to be managed in a way that falls
within IFSI.

187

3.6.1 below). It then considers investment
managers’ legal obligations and discretions
to use investment powers, stewardship andpolicy engagement to achieve sustainability
impact goals (see Section 3.6.2-4 below).

The following section starts by making
some preliminary observations on the roleof investment managers in the context
of IFSI in the light of the nature of theirrelationship with Asset Owners (see Section

contract with the Asset Owner or in
the general law, eg in common law
jurisdictions, duties of care in tort
which can also be modified (at least to
some extent) in the contract with theAsset Owner;• statutory requirements, including

regulatory rules; and• potentially, duties implied by law fromthe nature of the relationship with theAsset Owner, such as duties of loyalty
to the client requiring the investment
manager to avoid conflicts of interest.
189

An Asset Owner cannot confer on
its investment manager any greater
requirement or freedom to pursue
sustainability impact goals than it has
itself, and any investment managementagreement it enters into with its
investment managers should reflect
this (likewise any sub-delegations by theinvestment managers).86 Consequently,
however many layers there may be in

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
the investment chain, it is ultimately
the duties and powers of the Asset
Owner which will determine whether
investment managers must, or can, pursue
sustainability impact goals.
190

The introduction of investment managers
into the investment process can have an
impact on the use of IFSI. The following
highlights: (a) the potential it can create
for influence to be concentrated in thehands of investment managers, and its
significance for IFSI; (b) the way that Asset
Owners may need to approach the matterof sustainability impact goals in appointing
managers; and (c) the extent to which aninvestment manager may be able to pursue
sustainability impact goals where the termsof its appointment are silent on the subject.

(a)

The potential for concentrated influencein the hands of investment managers andits implications

191

The concentration of assets from anumber of Asset Owners in the hands ofinvestment managers can mean that, insome cases, investment managers are atleast as influential in their investment
and stewardship activities as the larger
Asset Owners, and potentially more so.
This concentration can help to reduce thecosts and improve the efficacy of these
activities compared to individual Asset
Owners acting alone. Subject to someof the conflict considerations discussed
below, this may in turn tip the balance infavour of pursuing sustainability impact
goals where, as noted previously, costefficiency and confidence in success arefactors in determining whether IFSI is105

legally required or permitted. Investment
managers are also active in public policy
engagement, at least in some jurisdictions,and the level of their assets under their
management may strengthen theirinfluence in that context.
192

193

However, this sort of concentration cancreate potential issues for Asset Owners
who may find that it reduces the scope for
their particular concerns to be addressed
through their investment managers.
Looking especially at stewardship activities,
it is not practicable for an investment
manager to apply a different stewardshipapproach for each client. Consequently,
an Asset Owner that has concluded thatit should use stewardship activities topursue sustainability impact goals, if it
is to rely on the investment manager for
this, will want to ensure, among otherthings, that the manager’s stewardshippolicy is sufficiently aligned with the Asset
Owner’s objectives, that the manager has
the resources and expertise to undertakestewardship as required, and that the
manager is not subject to unmanageable
conflicts that could prejudice its ability to
pursue the Asset Owner’s objective.
That said, stewardship is only one aspectof an investment manager’s overall
services. An Asset Owner may therefore
conclude that a manager’s other services
are sufficiently strong to outweigh minor
divergences between the manager’s
stewardship approach and its own,
recognising also that one reason forappointing a manager is to be able to relyon the manager’s judgement. However,if there were material divergences theAsset Owner might need to consider its
options. These might include, for example,
withdrawing stewardship of its assets
from the manager and undertaking theactivities in-house, or doing so selectively
in areas where it considers that theinvestment manager’s stewardship activity
is not sufficiently consistent with its own
investment goals. External engagement
service providers may also be an option.
194

In the UK, Asset Owners and investment
managers who are signatories to the
Stewardship Code should disclose theirconflicts policy under its Principle 3
and how that policy has been applied to
stewardship, including how conflicts havebeen identified, managed and addressed.
The Stewardship Code gives as examples,
conflicts that arise because of differences
between the stewardship policies ofinvestment managers and their clients;
differing bond and equity managers’
objectives within the same organisation;and client or beneficiary interests diverging
from each other. (Section 1.22 UK Report)(b)Appointment of investment managers by
Asset Owners

195

Across the jurisdictions surveyed, if
an Asset Owner is legally required or
permitted to pursue sustainability impact
goals, it would likely need to satisfy
itself when appointing an investment
manager, so far as reasonable, that, among
other things:• the terms of the investment

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

management agreement and supporting
documentation are clear about whatis needed in terms of investment andFreshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
stewardship services to enable the Asset
Owner to achieve those goals;

investment managers to establish theirclients’ ‘sustainability preferences’ andto be able to explain how ‘sustainability
factors’ have been taken into account in
the investment process.89 (Section 6.2.2
EU Report)• the period and terms of the appointment(including performance measurement
and monitoring) do not create incentives
that cannot be effectively managed, for
the investment manager to act in a waythat is inconsistent with achieving thosegoals; and• the investment manager is not subject

to any conflicts of interest which could
prejudice its ability to help in achieving
those goals which cannot be adequately
managed.87
196

197

106

In some jurisdictions, investment
managers have a duty to ensure that theirservices are suitable for their client’s
investment goals. These requirements
seem generally to have been understoodas referring to financial goals, although
they are not always drafted in ways thatare restricted to that. Even where they are
understood as being limited to financial
goals, it is not clear that this would
preclude consideration of the client’s needs
in relation to instrumental IFSI, sincethat is connected with realising financial
goals. Currently, few of the jurisdictions
surveyed expressly require that client’s
sustainability preferences are specificallyconsidered in this context, but it is clearthat many investment managers are
already raising this as part of their client
onboarding and renewal processes.88
The EU has recently amended the regime
operating under its Markets in Financial
Instruments Directive in a way that places
specific requirements on EU-regulated(c)

Investment managers pursuingsustainability impact goals where theinvestment management contract is silent

198

It seems likely that it will become rarethat an investment management contract
is silent on sustainability issues. Even
where that is the case, it is likely inmost jurisdictions that, in principle, aninvestment manager with broad powers
could nonetheless legitimately reach aconclusion on behalf of the Asset Owner
that it should pursue sustainability impact
goals within the scope of instrumental IFSI,
and to act accordingly. Indeed, that may
be happening in practice in the context ofsome stewardship activities. However, we
anticipate that managers may be reluctant
to take steps that could create a material
risk of adverse financial impact in the
short term, even where investment powers
were being used to enhance influence froma stewardship perspective, unless expressly
agreed with the Asset Owner.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

3.6.2 Use of investment powers to pursue
sustainability impact goals(a)Requirements to use investment powers
to pursue sustainability impact goals

199

Whether an investment manager isrequired to use its investment powers
to pursue sustainability impact goals inseeking to realise financial objectives (ieinstrumental IFSI) will depend on similar
factors to those for the Asset Ownerappointing it (see Section 3.3.1), but bealso subject to the terms of the relevant
investment management agreement andespecially the investment objective theinvestment manager is set. That said, it
is important to recognise that various
market features may tend to militate
against investment managers using theirinvestment powers (in particular) in thisway (see Part B.4.2.3 and 4). While there
have been policy and industry initiatives
in some jurisdictions to address these,
potential issues remain. Investment
management agreements are usuallyfor much shorter periods than thetime horizon of their clients. Financial
performance tends to be monitored by
Asset Owners and those who advise themon a periodic basis against industrywide benchmarks. Even if this is not the
primary or only means by which theAsset Owner rates the performance of its
manager, short-term under-performanceis uncomfortable for both parties. Asset
Owners who want their investment
managers to prioritise the longer term willneed (if their own duties permit it) to agree
on measures of success that reflect that.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
200

201

202

107

As with Asset Owners, investment
managers will need to comply with rulesthat exist in all jurisdictions that aredesigned to prevent various anti-social
activities (see Section 3.3.1(b)). As noted,
these regimes have an effect that is similar
to a collective ‘ultimate ends IFSI’ decision
by investors to achieve a reduction in therelevant activities, although it would not
be usual to think of them in that way.
Where an Asset Owner has discretion
to pursue sustainability impact goals
alongside its financial return objectives (ieultimate ends IFSI) and wishes to require
its investment manager to do this (iepotentially making it a legal obligation for
the investment manager), the details of,and prioritisation between, objectives toachieve financial returns and sustainability
impact goals should as a practical matterbe set out expressly in the investment
management agreement. However, it may
be difficult to define the balance, and tomeasure whether it has been achieved,
given the variable extent to which it ispossible to assess the sustainability impact
of investee companies and to weigh thevalue of that against financial goals (seePart A.2).
In Australia, it is possible that negative
sustainability impacts may have an
adverse effect on the value of the portfolio
constituents over the time horizons of theagreement. In such cases, an investment
manager may be required, pursuant toits duty of care, to consider what steps areasonable investment manager would
take in the circumstances (which may
include engaging in stewardship activity

for sustainability impact), even where
the investment management agreement
is silent on investing for sustainability
impact. In doing so, the investment
manager should have regard to themagnitude of the risk and the degree of theprobability of its occurrence, along withthe expense, difficulty and inconvenienceof taking alleviating action and any otherconflicting responsibilities which theinvestment manager may have. (Section
6.1.7 Australia Report)
203

In the EU, investment managers must
act honestly, fairly and professionallyin accordance with the best interests of
their clients. When providing investment
management services, an investment
manager must obtain the necessary
information as to the client’s investment
objectives so as to enable the investment
firm to select investments that are suitablefor it as part of the portfolio management(‘suitability test’). To date, there has beenno explicit legal duty to ask for the client’s
objectives regarding the sustainability ofthe portfolio, but ESMA has considered ita ‘good practice’ for investment firms toconsider non-financial elements and collectinformation on the client’s preferenceson ESG factors.90 The MiFID II DelegatedSustainability Regulation will introduce
obligation for investment firms to ask
for and reflect the client’s ‘sustainability
preferences’ as part of the client’s
investment objectives in the suitability
assessment that guides the investment
decisions.91 For this purpose investment
preferences are defined as a client’s or
potential client’s choice as to whether and,

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

if so, to what extent, one or more of thefollowing financial instruments shall be
integrated into his or her investment

EXECUTIVE SUMMARY• a financial instrument for which theclient or potential client determinesthat a minimum proportion shall be
invested in environmentally sustainable
investments as defined in Article 2, point(1), of SFDR;• a financial instrument for which theclient or potential client determines thata minimum proportion shall be invested
in sustainable investments as defined in
Article 2, point (17), of SFDR;• a financial instrument that considers

principal adverse impacts onsustainability factors where qualitativeor quantitative elements demonstratingthat consideration are determined by theclient or potential client. (Section 6.2.2
EU Report)(b)Discretion to use investment powers to
pursue sustainability impact goals

204

Investment managers may in somecases theoretically have the power,
even if not provided for in the relevant
investment management agreement, touse their investment powers to invest forsustainability impact on behalf of the Asset
Owner in circumstances where the Asset
Owner would have the flexibility to do so.
However, we are doubtful that investment
managers will do so unless this has been
specifically agreed with the Asset Owner,particularly where doing so may havesome negative impact on financial returns.
It is unlikely that doing so in a manner

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
that is inconsistent with pursuit of thefinancial objectives set in the investment
management agreement would ever bepermissible unless there was express andvalid authority to do so in the agreement.
205

In China, where the investment
management agreement is silent on
investing for sustainability impact, there issome flexibility for investment managers
to exercise investment powers forsustainability impact. However, investment
managers will be reluctant to consider
factors additional to financial return
absent clear instructions do to so. (Section
6.3.1 China Report)

3.6.3

Legal obligations and discretion to
engage in stewardship and public policy
to pursue sustainability impact goals

206

Investment managers’ stewardship
activities are by their nature undertaken
on behalf of all their Asset Owner clientscollectively. As discussed at Section
3.6.1(a), it is rarely, if ever, practicable fora single manager to offer a differentiatedstewardship approach depending on whichclient it is acting for.

207

108

Ideally, an investment managementagreement will expressly address thestewardship approach that will be adopted.
Although this is understood to not beespecially common at the moment, insome jurisdiction there is pressure for
Asset Owners to pay more attention
to this matter. At present, there may
be cases where stewardship has beendelegated to the investment manager
by a client knowing that the manager
has a house-wide stewardship policy,

but the agreement is otherwise silent on
stewardship. If so, subject to the manager
properly concluding that the stewardshippolicy it intends to pursue is in the bestinterests of its clients, it is unlikely to be
in breach of its duties to clients where
its stewardship activities are designed toachieve sustainability impact goals thatare reasonably likely to be financiallybeneficial or neutral for its clients (forexample, by reducing the potential foradverse investment impacts from systemic
sustainability risk and transition risk).
208

209

Section 3.6.1(b) above mentioned various
market features that could tend to militate
against investment managers using theirinvestment powers to pursue sustainability
impact goals. Since stewardship is lesslikely to have a direct impact on portfolio
composition than a manager’s investment
decisions, the influence of some of thesefactors may be less pronounced in relation
to stewardship activities. Others could
nonetheless create incentives for managers
not to devote resources to stewardship (seefurther in Part B.4).
In Australia, where the investment
management agreement is silent on useof stewardship powers for sustainability
impact, it may nevertheless be possible
for an investment manager to engage
in stewardship activities in relation
to portfolio constituents designed toreduce negative sustainability impact
if those stewardship activities arereasonably expected to contribute
positively and directly or indirectly tothe value of the applicable portfolio
over the relevant timeframe. A manager

is unlikely to be permitted to engage
in stewardship activities in relation to
portfolio constituents designed to achievesustainability impacts without that
contributing to investment return. (Section
6.2.1 et. seq. Australia Report)
210

In the Netherlands, it is possible
to foresee circumstances in which aninvestment manager takes a firm-wide
approach to stewardship activity acrossall of the portfolios it manages which
involves the manager seeking to achievesustainability impact (believing thisto be in the best interests of its clients
generally). While each situation would
need to be considered on its own facts, incircumstances such as this, where the Asset
Owner’s principal motivation is to accessthe manager’s investment expertise and theAsset Owner has not opted its assets out of
the manager’s stewardship programme, itwould be reasonable to conclude that theinvestment manager is authorised to pursue
sustainability impact in this way. (Section
6.1.5 Netherlands Report)

3.6.4 Policy engagement
211

As regards policy engagement, investment
managers are more likely to undertake
public policy engagement on their own
behalf (although potentially in supportof their market profile with clients andpotential clients), and at their own cost.
A manager engaging in activities of thissort is likely to need to satisfy itself thatthe policy positions it advocates for are
consistent with the interests of its clients,or that its clients are aware of and haveaccepted any potential conflict.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
3.7

Legal liability to third parties fornegative sustainability impact ofinvestee enterprises

212

This section looks at Asset Owners’
potential liability for any negative
sustainability impact of the companies
in which they invest, where negative
sustainability impact violates relevantlaws and/or causes harm to third parties.92
It also looks at whether investment
managers are likely to be legally liable forthe negative sustainability impact of thecompanies they cause Asset Owners toinvest in. 93

213

214

109

pay compensation to those affected (seeSection 3.7.2), or an administrative liability,
eg to implement remediation measures or
to pay for them (see Section 3.7.3).
215

216

The following discussion does not deal with
Asset Owners’ and investment managers’
liability to their beneficiaries and clientsfor the consequences of pursuing or not
pursuing sustainability impact goals.
Their basic legal duties in that regard are,essentially, addressed in the analysis above.
Where an enterprise causes certain
environmental or social damages (egpollution of a river with toxic wastewaterfrom a nearby battery factory or amisleading advertisement by a pharmacompany contributing to a widespreadharm to patients) most jurisdictions will
impose civil/administrative or criminal
liability on that enterprise and, often, on
the individuals who manage it, or who
took the decisions leading to the damages
in question. The question is whether an
Asset Owner that is an investor in theenterprise, or the investment manager
who caused the Asset Owner to makethat investment, may also incur criminal
liability (see Section 3.7.1), or a liability to

Neither Asset Owners nor investment
managers will incur liability in any
jurisdiction if the local laws do not impose
liability for the negative sustainability
impact of an investee enterprise. Whilecertain negative sustainability outcomes
do expose the investee enterprises to legal
liability, this is not always the case.
All jurisdictions recognise a possible legalrisk in certain circumstances for Asset
Owners and, generally to a lesser extent,
for investment managers. However,the likelihood of any form of liability iscurrently remote in most jurisdictions. In
general, an Asset Owner would need to havethe ability to exercise substantive control
over an investee enterprise before the acts
or omissions of the investee company could
be laid at the Asset Owner’s door.

3.7.1

Criminal liability

217

The systems of criminal liability differs
across the jurisdictions surveyed. In
some jurisdictions, both individuals andcorporations can be criminally liable.94 In
other jurisdictions, only individuals can becriminally liable, but other sanctions canbe applied to corporations.95

218

For an Asset Owner or investment manager(or its directors and other managing
personnel) to be held criminally liable
for the negative sustainability impact of
a company in which an Asset Owner has
invested, at least two requirements need
to be met. First, the investee company’s

219

220

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

activity which causes the negative
sustainability impact would need to beconsidered a criminal offence under theapplicable legal framework, as is the caseunder, among others, environmental laws
in a number of jurisdictions.96 Second, theAsset Owner’s or investment manager’s
investment in the enterprise concerned
would need to be deemed sufficient toinvoke criminal liability. Depending on
the legal framework, this would require
the Asset Owner or manager to, forexample, have ‘direct involvement in’ or‘be in control of’ the investee company’s
activities, or ‘act as a shadow or de facto
director of the investee company’. As thesestandards generally require substantial
involvement in the day-to-day management
and/or the internal decision-making of theinvestee company, they will only rarely
be applicable to the Asset Owners andinvestment managers with which thissurvey is concerned, who generally only
hold minority stakes or debt securities
in their investee companies and whoseordinary course stewardship activities do
not come close to the exercise of significant
control or influence.

INTRODUCTION

Thus, while in many jurisdictions there
is a theoretical risk of criminal liability
for Asset Owners, or their investment
managers, the risk is currently consideredvery remote.

ANNEXESIn the UK, it is unlikely that an Asset
Owner would be held criminally liable forthe negative sustainability impact of aninvestee enterprise. Exceptionally, criminal
liability might exist where an Asset Ownerhas direct involvement in the investee

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSI
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORMGLOSSARY
REFERENCES

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
company’s activities or operations, andwhere those are determined to be criminal
under the relevant legislation. In normal
circumstances the arm’s length nature of
relationships between an Asset Owner andthe activities of the enterprises included
in its portfolio makes such a liability
highly unlikely. The risks would be higher
if an Asset Owner had close day-to-day
involvement in and direction over theactivities of the investee company. Liability
is also theoretically possible, for example,
if a nominee director appointed by an Asset
Owner assumed managerial responsibility
over relevant activities of the investee
company. However, only exceptionally would
an Asset Owner exercise the required levelof engagement in an investee enterprise’s
operations. (Section 7.2.2 UK Report)
3.7.2

Civil liability

221

Asset Owners or their investment
managers could theoretically incur civil
liability to third parties who have sufferedharm as a result of a negative sustainability
impact caused by an investee enterprise.
However, usually that would only happen
in circumstances similar to those in which
criminal liability might arise; where theAsset Owner, or its investment manager,
has de facto control of the enterpriseconcerned. Even then, the claimant would
most likely need to show both that its loss
had been caused by the acts or omissionsof the Asset Owner or investment manager,that the Asset Owner or investment
manager owed them a legal duty of carein the way that they exercised their rights
with respect to the enterprise, and thatthe harm caused to the claimant was areasonably foreseeable consequence of the110

acts or omissions of the Asset Owner orinvestment manager.
222

223

224

For civil liability to arise, the Asset Owner
or investment manager’s own acts oromissions (and not merely those of theenterprise concerned) in relation to thenegative sustainability impact would thus
need to be found to have a sufficient causal
link to the harm suffered by the third
party.97 Depending on the legal regime thismight require the Asset Owner or manager
to ‘exert a sufficient degree of control or
influence’ over the investee company in asituation where the harm to the claimantwas ‘reasonably foreseeable’, ‘wilfully or
negligently prompt the investee company
to commit a tort’, be ‘in control of theinvestee company or its activity’, or have ‘asignificant level of involvement and control
in the day-to-day operations of the investee
company and decision-making’. Thesestandards generally require substantial
involvement in the day-to-day management
and/or the internal decision-making of theinvestee company, which will very rarely
be the case with Asset Owners or theirinvestment managers.
Thus, while in all jurisdictions civil liability
for Asset Owners could theoreticallyarise, the risk is currently consideredvery remote except for entities in which
the Asset Owner holds, or the investment
manager’s clients have (and exercise), a
controlling interest. However, there is one
notable exception in relation to Brazil.
In Brazil, the Brazilian National
Environmental Policy (Política Nacional
do Meio Ambiente) establishes strict civil
liability for environmental damages,

meaning that only the chain of causation
between the activity performed by thepolluter and the environmental damage
needs to be verified. The Brazilian High
Court of Justice (Superior Tribunal deJustiça – STJ) held that any party that (a)fails to prevent, or acts with indifference
to, polluting activities; (b) fails to reportsuch activities to authorities; (c) finances
those that carry out such activities; or (d)benefits from such activities, is deemed
to be an indirect polluter. In otherrelevant case law, the STJ clarified thatthe indirect polluter concept encompasses
all those who have a duty to prevent anenvironmental degradation and fail to doso, profiting, even if indirectly, from thirdparty actions that lead to environmental
harm. This far-reaching concept could, intheory, comprise all Asset Owners which
contribute to companies or projects that
result in environmental damages. So far,the legal rules have only been tested withregard to financial institutions. (Sections
7.2.7 et. seq. Brazil Report)
225

In the Netherlands, recent case law
indicates that liability for negative
sustainability impact could potentially be
attributed to business enterprises or the
Dutch State on the basis of the duty ofcare in the context of the tort article in
the Dutch Civil Code (Burgerlijk Wetboek),
Article 6:162. In addition, the approach of
the courts in the Milieudefensie/RDS98 andUrgenda99 cases highlights the importanceof ‘soft law’ (such as commonly recognised
industry standards of good practice) in
determining the scope and content of the
duty of care, specifically in the context ofclimate cases. Even though we have not

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
seen such civil cases against Asset Owners
or investment managers, this does increase
the risk of direct tortious liability forinvestors for negative sustainability impact
in the relatively limited circumstancesin which such direct liability could arise.
(Section 7.2.25 Netherlands Report)
226

111

In South Africa, Asset Owners ‘incontrol’ of an entity or activity whichcauses pollution could have criminalor civil liability under the National
Environmental Management Act,
1998 (NEMA).100 NEMA recognises anenvironmental duty of care, placing
an obligation on everyone who causes,
has caused or who is likely to causesignificant pollution or degradation to theenvironment to take reasonable measures
to prevent or stop such harm, or where theharm is authorised under law or cannot
reasonably be avoided, to minimise and/or rectify such pollution or degradation.
For liability to arise, claimant(s) would
need to prove the elements of a delict(conduct, wrongfulness, fault, causationand damage). The likelihood of liability innegligence for a minority shareholder (asan Asset Owner or investment manager
would typically be) is remote absent specificmanagement rights or involvement. (Section
7.2 South Africa Report)

227

228

In the UK, it is possible that, in certain
limited circumstances, an Asset Owner
could be found to have a duty of care
towards individuals harmed by an investee
enterprise’s acts or omissions which resultin a negative sustainability impact, ie
liability in negligence. While there are now
a number of scenarios in which a duty ofcare could be owed by a parent company
in respect of its subsidiary’s activities,101
the likelihood of liability in negligence fora minority shareholder is remote: not only
must the harm caused by the negligent
act or omission have been reasonably
foreseeable, but there must be sufficient
proximity between the parties (ie between
the Asset Owner and the affected third
party) for it to be ‘fair, just and reasonable’
to impose liability to a third party on theinvestor entity.102 These requirements arevery unlikely to be met in relation to theusual activities of an Asset Owner of thetype described in this report.103 (Section
7.2.7 UK Report)
In the US, outside of certain specificregimes, it is difficult to hold Asset Owners
or investment managers liable to third
parties for the negative sustainability
impact of enterprises in which investments
are made. Such cases have so far been
largely unsuccessful due to constitutional
grounds (lack of standing, justiciability) or
evidentiary grounds (difficult to prove that
alleged tortious behaviour caused negative
sustainability impact). (Sections 7.2.1 et.
seq. US Report)

229

The risk of civil liability for investment
managers is even more remote thanfor Asset Owners. While it is true thatinvestment managers often take decisions
with respect to the exercise of votes
attaching to the Asset Owners’ portfolios
and engage in stewardship more broadly,
this will rarely be the case except in the
exceptional situations where an Asset Ownerhas a controlling interest in an enterprise.

3.7.3

Responsibility vis-à-vis governmental
authorities

230

This section deals with obligations ofprivate persons including corporate entities
vis-à-vis governmental authorities; such as
the obligations of a polluter to implement
or pay for remediation measures areadministrative legal obligations.104 In
civil law jurisdictions this is known as‘administrative liability’; in common law
jurisdictions, those would be categorised as
civil (as opposed to criminal) liability.

231

232

In principle, Asset Owners or investment
managers could be subject to such aliability for the negative sustainability
impact caused by an investee enterprise inlegal systems and in circumstances where
the state can look through a corporate
entity and pursue those who control it fora remedy (‘piercing the corporate veil’).
Pollution of land is a particular example.
While EU law does not directly govern
administrative liability for negative
sustainability impacts, Directive 2004/35
on environmental liability (Environmental
Liability Directive)105 has establisheda framework of strict environmental
liability based on the ‘polluter-pays’

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
principle for certain cases.106 Under the
Directive, member states are to oblige‘operators’ of certain activities whichhave caused environmental damage to,inter alia, implement remedial measuresand bear the costs for those measures.107
It does not, however, provide for claims
by private parties against the polluters.108
An ‘operator’ is broadly defined as, ‘any
natural or legal, private or public person
who operates or controls the occupational
activity or, where this is provided for innational legislation, to whom decisive
economic power over the technicalfunctioning of such an activity has beendelegated, including the holder of a permit
or authorisation for such an activity or
the person registering or notifying suchan activity.’109 Asset Owners or investment
managers could in theory, dependingon the size of their investment relative
to other shareholders in the relevant
investee enterprise, be regarded as either
controlling its activity or as having decisive
economic power over the technicalfunctioning of such an activity.110 (Sections
7.1.6-7 EU Report)
233

112

In South Africa, certain environmental
statutes require the development of certain
infrastructure to be authorised prior todevelopment and failure to obtain therequisite authorisation would attract
significant sanctions. If a person fails tocomply with the duty of care or permitting
obligations imposed by these statutes, theenvironmental perpetrator may have to
pay a fine and/or remedy the harm done tothe environment. The term ‘administrative
liability’ is not specifically used in South

African legislation, however administrativefines are imposed in terms of NEMA (ieofficials impose fines administratively
without the intervention of the court).
Separately, direct clean-up/remediation
liability can be incurred where a person
causes or negligently fails to prevent
pollution. However, there would need to besome element of ‘control’ or involvement
at operational level by the Asset Owner
or investment manager to incur liability(Section 7.2.4 South Africa Report)

235

236

There is currently a developing trendof complaints being made by NGOs
to regulatory bodies on the basis ofalleged breaches of the OECD Guidelines
for Multinational Enterprises (OECD
Guidelines). The OECD Guidelines
are recommendations addressed bygovernments to multinational enterprises
operating in or from adhering countries.
They provide non-binding principles
and standards for responsible businessconduct in a global context consistent
with applicable laws and internationallyrecognised standards.
Complaints of this sort, usually allegationsof non-disclosure or contribution toenvironmental damage, are not part ofa legally binding process but have thepotential to cause significant reputational
damage, and the usual outcome is for theparties to reach agreement on addressing
the conduct concerned.

INTRODUCTIONACKNOWLEDGEMENTS

to provide a mediation and conciliation
platform for resolving practical issues that
may arise with the implementation of theOECD Guidelines or their non-observance.
237

3.7.4 OECD Guidelines
234

FOREWORDS

238

There are examples of complaints against
financial investors under these guidelines,
and they could be a source of reputationalrisk for Asset Owners or investment
managers, either directly or indirectly ifthey are identified as a significant investor
in the offending enterprise. They do not,however, carry any direct risk of financial
exposure for Asset Owners and investment
managers, and there are no examples todate of specific complaints being madeagainst non-controlling shareholders in
multinational enterprises, as opposed tothe enterprises themselves.
In Australia, NGOs are increasingly
making complaints to Australia’s NCP
alleging breaches of the OECD Guidelines.
Though complaints have not yet been
made against Asset Owners or investment
managers,111 the Australian NCP iscurrently considering a matter involving
a bank’s financing of an entity linked
to forcible evictions and human rights
abuses, and a number of other similar
matters have been brought indicatingsome potential for future complaints to
be made directly against Asset Owners
or investment managers.112 (Section 7.2.6
Australia Report)

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Governments adhering to the OECD
Guidelines are required to set up a National
Contact Point (NCP). These are intended

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
239

as Rabobank and ING should makemore effective efforts to mitigate or
prevent the adverse impact of palm
oil plantations through their business(lending) operations. In its final
statement in the complaint procedureagainst Rabobank the NCP inter alia
stated that financial institutions have a
responsibility of their own to exercise
individual leverage to seek to preventor mitigate the impact of their businessconduct and respond to identified
adverse impacts through engagement or
potentially divestment. 114

In the Netherlands, there have been
three complaint procedures under the OECD
Guidelines initiated by NGOs against Dutchbanks – one against Rabobank and two
against ING Bank.113 The complaints mainly
focus on the banks’ financing role in relation
to business enterprises, which evidencesthat complaints of this sort could also belevelled at Asset Owners if their involvementin negative sustainability impact enterprises
were sufficiently significant.
• The basis for one of the complaints

against ING by a number of NGOs
was that ING continued to provide
significant investment to parties in thefossil fuel sector (eg the coal industry),
breaching the OECD principles relating
to environment and climate. The NGOsargued that ING should publish its total
carbon footprint (including indirectemissions as a result of ING’s loans andinvestments) and ambitious, concreteand measurable emission reduction
targets for its loans and investments.
The procedure before the Dutch NCP
resulted in a statement by the NCP that afurther dialogue between the NGOs and
ING was justified.
• The other two complaints procedures

relate to Rabobank’s and ING’s business
operations in relation to palm oil
plantations. In short, a number of NGOsargued that financial institutions such

240

The complaint procedure against ING is
still ongoing and in January 2020, the NCP
issued a statement that this complaint
merits further consideration and that it
will facilitate a dialogue to bring parties toagreement on possible improvements to
ING’s due diligence policies and practices
regarding palm oil business financing, andto assess its involvement with actual or
potential adverse impacts to determine theappropriate responses.115 (Sections 7.2.27-33
Netherlands Report)

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summaryof findings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

113

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
4.

DO EXISTING MARKET FEATURES CREATE A RISK THAT SUSTAINABILITY FACTORS ARE GIVENINSUFFICIENT WEIGHT BY INVESTORS IN COMPLYING WITH LEGAL DUTIES?

241

As noted previously, what legal rules
require or permit in relation to IFSI turns
not just on what they ‘say’ (their ‘black
letter’), but also the circumstances inwhich they are applied. Among otherthings, these circumstances may limit
what is possible, for example, as a technicalmatter or in terms of cost (see Part A.2).
However, the surrounding circumstances
can also influence decisions that get madeabout how to follow rules in practice byaffecting what is thought to be relevant tothose decisions.

• First, the circumstances in which rules

are applied can frame the decisions of
those to whom they apply about what
the rules require or permit. If existing
market features do draw attention awayfrom sustainability factors, then it could
mean that investors do not pay sufficientattention to them in complying with
duties or exercising discretions,
including decisions on whether toengage in investment activities within
the scope of IFSI.
• Secondly, in considering whether aninvestor has complied with its legal

Box 5:
How accepted market practice can affectthe way legal rules apply
The role of accepted market practice in official
construction of legal rules
While there will be differences of emphasis
between jurisdictions, if an investor were accusedof breaching its duties, a court or regulator would
be likely to consider all relevant circumstances
including many of those outlined in Part B.2.2.
However, in addition to these, the court or regulator
may also assess the actions of the investor byreference to established professional practice.
Where an investor has reached conclusions anddone what would be considered appropriate bya respected body of professional practice, then aclaim is generally less likely to succeed.
This means that legal obligations are likely to adjustin the light of changes in professional practice. For
example, a greater professional consensus that
more account should be taken of sustainability
factors could lead to a stronger obligation to do so.
Conversely, professional practice could also create

114

inertia; for example, if the professional mainstream
were to remain focused on short-term financial
factors it could result in investors feeling lessconfident from a legal perspective that they arecomplying with their duties by giving weight tolonger-term sustainability factors.
However, in taking account of professional practice,courts and regulators are likely to recognise that
there are various schools of professional thought,that different groups of professional opinion may
favour some approaches over others in a given
situation, and that current market practice may not
in fact be appropriate or should only be relied upondiscerningly. Consequently, investors should be
careful to understand the limitations of professional
theory and practice and not follow it in ways thatare inappropriate. They also need to be aware of
how it may be changing. This Section 4 highlights
a number of ways in which current market practiceand investment theory could potentially exert an
influence on investors that is not necessarily alignedwith their duties as they concern the pursuit ofsustainability impact goals.

duties, a court or regulator may, among
other things, assess the investor’s actions
by reference to established professional
practice (see Box 5). Where an investor
has reached conclusions and done what
would be considered appropriate by arespected body of professional practice,then a claim is less likely to succeed.
Consequently, if sustainability factors
are being inappropriately underweighted
in the course of existing market practice,then legal duties could unintentionally
add impetus to that because of the way
those duties interact, or are believed tointeract, with market features.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

Market practice and the market application oflegal rules

3.

IFSI in eleven jurisdictions - Summary offindings

Investors may also sometimes mistakenly believethat legal rules require them to follow a particularmarket practice or theory in a way that those rules
do not. Some of the prolonged debate surrounding
the integration of ‘material’ ESG factors in theinvestment process as compared with the pursuitof ‘risk-adjusted return’ (understood in terms of
portfolio theory and performance against traditional
benchmarks) may be an example of this. Indeed,
the expression ‘risk-adjusted return’ is associatedwith contemporary portfolio theory (the risk beingreferenced is, essentially, volatility risk and does notcover, for example, systemic risk). While sometimes
used in discussing compliance with legal duties,
the expression is rarely used in articulating theduties themselves, which tend to be more neutrally
drafted; in other words, legal rules requiring
investors to seek to achieve a financial return do notnecessarily require investors to do so by applying
modern portfolio theory even if language used bysome market participants to describe investor duties
might be taken to suggest otherwise.

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
242

243

244

115

If existing market features do create arisk that sustainability factors are given
insufficient weight in investors’ decisions,investors need to understand the issue andensure that they nonetheless comply with
their duties. There may also be a role forpolicymakers (Part C.2).
In the many discussions we have hadwith market professionals while working
on this project, it has frequently beensuggested that there are certain market
features that result in sustainability
factors being underweighted. We are
not investment professionals and thisis a legal project, so the following is notbased on an in-depth review of market
practice or investment theory and ourconclusions are necessarily somewhattentative. However, for the reasons
outlined below, it does seem plausible thatthe market features described do createa risk that sustainability factors are notgiven sufficient weight in by investors inpractice. That said, we anticipate that there
will be a range of views on this topic.
If there is such a risk, the issue merits
further attention from policymakers,
investment theorists, and asset owners,
investment managers and their respective
consultants (including lawyers) to ensurethat institutional investment is achieving
its goals and that those taking investment
decisions comply with their duties. We
have been told on a number of occasions
while working on this project that therisk of sustainability factors not receiving
sufficient weight in the investment process
results from ‘modern portfolio theory’.
The assumptions behind current portfolio

theory may indeed be involved and needmore scrutiny. However, a more complex
interplay of informational, behavioural,commercial and legal factors seems to be
at work.
245

4.1

246

247

realise a sustainability impact goal partly
for its own sake (ultimate ends IFSI). The
following section principally considers
whether market features create a risk inrelation to the first: taking in isolation
legal duties to secure a financial return,
could market features lead to sustainability
factors being underweighted in discharging
those duties including, for example,
duties to treat fairly different cohorts ofbeneficiaries some with shorter and otherswith longer-term interests in the relevant
investment arrangement? In particular, theissue is:The following outlines potential issues
that have been drawn to our attention.
However, we start with a brief look at thecritical connection between investment
objectives and the weight given to any
factor in pursuing them.
Relationship between investment
objectives and the weight given tosustainability factors
The idea of a particular factor not receiving
sufficient weight in a decision only makes
sense by reference to the objective of theperson making the decision – their goal or
purpose. This determines which factors are
relevant to the decision and their degree of
relevance. A person visiting a shop to buy
breakfast cereal does not need to check out
the cheese counter to come to a decision.
However, they might consider the contentslabel on different cereal boxes, as well as
price, to select the cereal that most suits
their goals. For some, the sugar content orwhether the ingredients are organic may
be more relevant to their objective thanfor others. A person may not make a gooddecision if a box does not give them thenecessary information.
This report has identified two broad sets ofobjectives that investors might be pursuingwhen investing for sustainability impact:
first, IFSI could be a step in delivering afinancial return (instrumental IFSI) and,secondly, an investor could be seeking to(a) whether certain market features
result in the near-term financial
performance of investment portfolios
being prioritised over longer-term
performance (on the understandingthat it is in the longer-term thatsustainability factors are more likely
to have a material impact on financial
performance); and(b) whether these market features could
also limit attention to sustainability
factors which could have an impact
within a shorter timeframe, by
narrowing the range of factors thatare commonly taken into account ininvestment decisions.
248

249

If market features do create these risks,
it is reasonable to suppose that they may
also militate against the exercise of any
discretion which may exist to engage inultimate ends IFSI.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

The market features concerned bear mostdirectly on investors’ use of investment
powers. However, they are also relevant

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
to investors’ decisions to address
sustainability issues in their stewardshipand public policy activities. For example,
if investors are unaware of the potential
impact of sustainability factors they cannot
address it. Further, improved sustainability
outcomes through stewardship and policy
activity are only likely to be achieved overthe long-term, and a short-term focus is
not well aligned with this.
4.2

250

4.2.1

251

116

lend themselves to easy quantification, and(d) the fact that the long-term consequencesof some risks are not easily foreseeable.
252

Market features and the risk thatsustainability factors are given
insufficient weight in complying withlegal duties
A number of market features are
considered individually below, but they areinter-related.
Transparency and uncertainty about
potential impact of sustainability
factors on investee enterprises
Most investors are likely to accept thatsustainability factors can be a source ofrisk both to the financial performance ofparticular investee enterprises and to thesystems on which those enterprises andwhole markets depend. However, it is notpossible for investors to assess and address
sustainability risks and opportunities
without adequate reliable information bothas to the nature and severity of the risks
for the system as a whole and in relation toindividual portfolio investments. There arevarious interlocking issues here including(a) whether the information is available
but not being adequately disclosed, (b) the
possibility that relevant data may not yet
exist and needs to be generated, (c) the factthat some sustainability-related risks do not

253

Climate change is currently the mostobvious and pressing sustainability
issue for most investors. Yet, even in
relation to this widely recognised risk, it
is acknowledged that markets currently
have insufficient information either as tothe nature and severity of the ultimate
risks if carbon emissions are not reduced
as agreed in the Paris Agreement or as tothe financial and business implications of
the transition to carbon neutrality.116 For
example, there may be ways of predicting
how sea levels could rise at certain degrees
of global warming, but the extent of thatwarming may not be easily predictable andthe secondary implications, such as thoseresulting from potential social disruptionand ‘climate migration’ are even less so.
However, climate change is not the only
sustainability risk.
In recognition of the need for better
information, as noted in Part A.2,
considerable work is underway to enhanceand standardise corporate disclosure
on sustainability issues more broadly.
However, this will not necessarily address
the kind of uncertainties mentioned above.
In any event, as things stand, without
adequate information or consensus on
the sustainability risks confronted byinvestee enterprises and their strategy for
responding, it is reasonable to supposethat sustainability factors are not receiving
sufficient attention from investors or those
providing services and advice to them andare not reflected adequately, or at all, in

share prices. The issue concerns the quality
and usefulness of available information(including the ability to compare data fromindividual investee companies) as much as
or more than its quantity.
4.2.2 Indices and benchmarks
254

255

256

If the price of individual investments
systematically takes insufficient accountof sustainability factors, then those factors
will also not be fully reflected in the value
and performance of indices in which thoseinvestments appear. There are potentiallystrong incentives on investors to ‘follow
the market’s lead’, as represented by these
indices, creating a risk that sustainability
factors will also therefore receive
insufficient attention in the managementof their portfolios.
The level of an investment index is anumber showing the variation in themarket prices/values of some specified setof investments or other financial factors
since a chosen ‘base’ period. Traditionally,
the purpose of indices was to provide a
guide to the economic performance ofand sentiment in a particular market or
economic sector. The selection of index
constituents is typically based on predetermined rules.
Indices are commonly used as benchmarksin the investment sector. Benchmarks
perform an additional function as a pointof reference for performance measurement
and evaluation, in particular, in assessing
progress towards achieving a given
investment goal or objective.117

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
257

258

Consequently, if an index measures theprice-based performance of a market or
sector in which the market prices of index
constituents do not adequately reflect
the exposure of the relevant businesses
to sustainability factors, and that index
is used as a portfolio benchmark, thebenchmark will provide a basis for action
and measurement that also does not give
sufficient weight to sustainability factors.
If, as a result, the portfolio comes to reflect
the composition of the index, the return on
the portfolio will have a similar exposure
to the risks created by sustainability factors
so that it is potentially unsustainable overthe longer term.

on the nature of its legal duties.
However, there could be legal riskeven for those obliged to do no morethan track the relevant index unlessthey have made clear to beneficiaries
that this means the beneficiaries havea financial exposure to sustainability
risks. While index tracking leaves aninvestor with little or no discretion touse its investment powers to pursue
sustainability impact goals, it does notprevent the investor from undertaking
stewardship or public policy
engagement, although the extent of
portfolio diversification involved may
affect incentives to do so (see Box 6).

Indices and benchmarks are extremely
important in investment practice,particularly in decisions on portfolio
composition. Modern portfolio theory (seefurther below) has had a major influenceon this. However, they would have a rolein investment practice even without
that. The potential implications for how
sustainability factors are taken into
account in the context of two of the mainfunctions of indices and benchmarks are
as follows.

(b) Active investment management.
Benchmarks have a key role in active
portfolio construction and performancemeasurement. Where the benchmark
index does not adequately reflect thepotential impact of sustainability
factors, those factors may also,
therefore, not receive sufficient weightin the way the portfolio is managed, atleast in relation to investment decisionmaking: effectively, it creates a pressure
to over-weight short-term profit-taking
even though the crystallisation ofsustainability risks could result inshort-term gains proving to be illusory.
However, again, an investor canstill engage in sustainability-related
stewardship or public policy work
to address the risk. Depending on
the precise approach of the relevant
investor, the benchmarks it adopts
or against which its performance ismeasured may effectively function(a) Passive investment management.
Indices provide a basis for runningpassive investment portfolios, investingin the index constituents in the
proportions represented in the relevant
index. Consequently, an investor will
be financially exposed to sustainability
risks where its portfolio tracks anindex that does not adequately reflect
those risks. Whether that also creates
legal risks for the investor will depend

117

as a starting point for portfolio
selection. Benchmarks are also used
as a way of targeting and assessing
the level of ‘active risk’ an investor isundertaking (ie broadly, the additionalrisk of diverging from the benchmark
in the interests of outperforming
the benchmark). As a result, risk
measurement in an investment context
can become too closely associatedwith the risk of not performing
against benchmarks rather than therisk of not providing an appropriate
investment return for beneficiaries,
with insufficient regard to the role ofsustainability factors in that.
259

Consequently, unless it is possible toconclude that market prices/values
underlying a benchmark index already takesufficient account of the impact of relevant
sustainability factors, there is a weakness
in one of the investor’s key tools to assist
it in realising its objectives. Especially forinvestors with longer-term investment
objectives, the idea that the most commonlyused benchmarks do adequately factor in
relevant sustainability risks requires one
to believe that the market in all material
respects perfectly anticipates the natureand extent of the risks. Given the problems
highlighted above with the quality andusefulness of sustainability related
information and fundamental uncertainties,
that does not seem a reasonable belief.
Yet, for some of the reasons highlighted
below, market factors and portfolio theory
may nonetheless create an environment
in which investors are reluctant to diverge
from benchmarks.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI260

The level of diversification involved where
portfolios are closely aligned withmainstream market benchmarks could
reduce investor attention to sustainability
factors in other ways. This is consideredfurther in Box 6.

duty to meet; as noted in Part B.2,
Box 1 they may need to perform achallenging balancing act;(d) where an investor with longer-term
financial investment objectives appoints
an investment manager, it is unlikely
as a legal matter to be able to binditself to use that manager throughoutthat longer term, regardless of its
performance. It is usual to appoint formuch shorter periods. This and theother legal terms of the manager’s
appointment are likely to mean thatthe manager’s investment objective
and the periods by reference to which
its investment performance will bemeasured are shorter than those that
apply to the investor (see further on thechallenges created by intermediation,
below);119 and4.2.3 Investment time horizons andperformance measurement periods
261

262

The longer the period by reference towhich a portfolio is being managed, themore likely it is that sustainability factors
will be relevant in some way. Yet it is often
suggested that there is an issue of shorttermism in investment markets.118 Focus onshort-term investment performance could
be driven by a combination of factors.
For example, in some cases legal duties, somereflecting structural factors, may prioritise
investment with a shorter-term focus:(a) where there is an extreme adverse
market event, investors may conclude
that they are legally required to takeshort-term decisions to protect thevalue of their portfolio whatever theiroverarching investment time-horizon;(b) investment objectives may be framedin ways that emphasise shorterterm investment performance; forexample, the investment objective ofa mutual fund could be referenced toa particular market benchmark (as towhich, see Section 4.2.2 above);(c) investors, such as pension funds, with
duties to beneficiaries in the long-term
are likely also to have beneficiaries
with shorter-term financial needs
which they are also under a legal

118(e) in some cases, investment restrictions
that apply to asset owners, forexample, that are designed toensure liquidity so that beneficiary
entitlements can be paid when due
or to limit investment management
expenses, may mean it is difficult tomake investments that are illiquid in
the short-to-medium term or which
may also involve higher levels ofmanagement expenses.120
263

Further, even where an investor has longterm financial objectives, it may not beeasy in practice to assess its performancein progressing towards them, as comparedwith considering its shorter-term historic
performance. Unless short-term underperformance can be explained by reference

to investments that will pay off in thelonger-term (and which could not havebeen secured but for the decisions thathave led to the shorter-term underperformance) how can one be confident
that short-term under-performance is not asign of mismanagement?
264

In addition, simply as a matter of humannature, an investor’s performancein generating a financial return will
inevitably be compared with theperformance of relevant investment
markets, other investors and similarfunds, even if there is little obvious
reason to do so considered from theperspective of its long-term investment
objectives. Regardless of their legal duties,
the individuals or firms responsible formanaging a portfolio may therefore fearthat their appointment will be terminated
where performance falls short by reference
to these shorter-term criteria. This would
give them an incentive not to stray too far
from common performance benchmarks
and approaches adopted by other investors,
diverting attention from the fundamental
value of enterprises and sectors in which
they invest.

4.2.4 The challenges created byintermediation in the investment
process
265

The difference between asset owners’
overarching investment objectives andthe shorter-term investment objectives
they have to set for their investment
managers was highlighted above (Section
4.2.3). Investment managers are generally
appointed for periods that are shorter than

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
the overarching financial objectives of
the asset owner and, consequently, theirperformance is assessed by reference tothat shorter timeframe and periodicallyduring the term of their appointment.
266

267

268

119

It seems inevitable that these shortertime horizons could tend to result inmanagers focusing on their short-term
performance relative to other managers,
rather than working to increase the longterm value of portfolio assets. In addition,
investment managers’ fees are often set asa percentage of the value from time-to-timeof the assets under their management.
This could incentivise them not to selectassets they believe may underperform inthe short term even if there is potential for
longer-term upside consistent with theirclient’s long-term investment horizon.
Likewise, there is an argument thatinvestment managers may not be
sufficiently incentivised to undertakestewardship or policy engagement if
the benefits (in terms of portfolio valueenhancement or protection) are likely tobe realised long after the period of their
appointment. Investment managers may
also face client conflict issues in relation
to stewardship, in particular if different
clients are best served by differing
engagement approaches.
That said, investment managers generally
aspire to be reappointed so that theaggregate period of their appointment
could effectively be long-term. Further, weare told by asset owners that the qualityof an investment manager’s sustainability
stewardship and wider engagement

activities is emerging as a distinguishingcompetitive feature in the award of future
mandates as more clients recognise theneed for this capability.
269

For these reasons, asset owners should
recognise that investment managers areunlikely to be naturally focused on thelonger term, and so will need to takeextra care to ensure that the terms ofthe manager’s appointment (or, where
the manager’s expertise is accessedby investment in a mutual fund, theway the fund is operated), the way the
relationship runs in practice and thecommercial incentives involved are, so far
as possible, aligned with the asset owner’s
financial objectives and legal duties. In
addition to the manager’s expertise ininvestment selection, asset owners may
to need to consider its stewardship andpolicy engagement capacity where these
are needed in pursuing the asset owner’s
investment objectives. Asset owners
should recognise that the mismatch intime horizons between them and theirinvestment managers has the potential
to create a structural obstacle (whichasset owners need to work to overcome)to effectively addressing systemic risksof a sort that could impact portfolio
performance in the long term.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

4.2.5 Short-term trading activity
270

271

272

Even if markets were perfectly informed
about sustainability exposures, short-term
investment prices and their volatility are
not necessarily the result of fundamental
assessments of enterprise value.
A significant portion of the turnoverin public investment markets involves
short-term trading. There are conflicting
views about whether this activity results
in a truer valuation of the underlying
enterprises, but it is doubtful that much of
it is focused on longer-term issues such assustainability factors.
Nonetheless, prices formed in this way
influence wider investment activity, forexample, because they are reflected incommon portfolio benchmarks (see section
4.2.2 above) or price and volatility data isused in portfolio modelling (see section
4.2.6 below). Investors of the sort coveredby this project would not routinely engage
in short-term trading. It is nonethelessreasonable to suppose that it could drive agreater focus on shorter-term factors.121

4.2.6 Portfolio theory
273

Prevailing portfolio theory has tended tofocus attention on managing risk and returnat investment portfolio level, structuring
the portfolio as a whole to realise themost efficient ‘risk-adjusted return’. Thisis fundamentally important for investors.
Nonetheless, in addressing risk at a portfolio
level there is a question as to whether it
could result in insufficient attention torisks posed at individual enterprise level bysustainability factors and to the systemicrisks to which a portfolio is exposed.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
274

275

Current investment practice and risk
management has been heavily influenced
by various models and theories, which canloosely be described as ‘portfolio theory’ or‘modern portfolio theory’.122 The expression‘modern portfolio theory’ harks back to thework of Harry Markowitz, the key insight ofwhich has been that portfolio diversificationcan (as long as the portfolio constituentsare not correlated) reduce investment risk
at portfolio level without reducing the
expected investment return.123
Portfolio theory has since built out
considerably from that. Elements ofcontemporary portfolio theory include:(a) the ‘efficient market hypothesis’,
which is based on the common-sense
observation that investors tend to act
on available information so that itis reflected in the price of securities,
but which, in some forms, takes thatfurther to propose that market prices
reflect all relevant information (withthe implication that it is difficult for
an investor to outperform ‘the market’
consistently over the longer-term);124(b) the ‘capital asset pricing model’ or‘CAPM’, which seeks to predict, using
a formula, the relationship between
the risk of an asset and its likely
return, allowing an investor to assess
whether the return it has achieved isappropriate given the risk undertaken(risk being taken as the volatility of
the returns on an investment relative
to those of other investments in themarket, the greater the price variations
the more risky the investment); and120(c) ‘value at risk’, which seeks to assess
the loss that could be incurred upon
the occurrence of an event that
could result in a material change ininvestment prices.
276

Applied discerningly, these sophisticatedtheories and models provide a powerful setof investment tools. This helps to accountfor their widespread use. However, theyalso suffer from well-known limitations,some of which were brutally exposed by
the 2008 financial crisis.125 They therefore
need handling with care. Some of those
we have spoken to over the course of
the project have suggested that market
operators are not always doing that.126
If so, this is potentially important forthe subject of this report in particular,
if it leads to sustainability factors being
underweighted in investment decisions ina way that is inconsistent with discharging
legal duties. Limitations that seem
relevant to that include:(a) the assumption that all investors are‘financial utility maximisers’, rationallyseeking to earn a given financial
return at the lowest possible risk tothemselves, with little interest in thewider impacts of their investments(for example, on sustainability factors).
At least as regards their rationality,and probably their motivations moregenerally (see Part A.4), this is clearly
not always the case;

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS(b) the equation of the ‘risk’ of aninvestment with the volatility of its
return relative to the market:(i) volatility risk tells us little of theimpending risk to investment
performance of sustainability
factors. Indeed, it is likely thatmuch volatility can be accounted
for by market sentiment,
which may have little to dowith the underlying value ofinvestee enterprises (so that, tosome extent, it is a measure ofemotion more than enterprise or
performance risk);(ii) the use of volatility also makes
it necessary to identify markets
by reference to which volatility
and investment success can bemeasured (so giving impetus tobenchmark usage based on market
capitalisation-weighted indices,
as to which, see above).127 It alsothen carries a further possible
implication: that ‘success’ for aninvestor (ie the investor’s objective)
should be to outperform thebenchmark-defined market whencompared with other investors
taking similar levels of risk (or atleast track the market) rather thanbeing based on what is needed toachieve the investment outcomesthat the investor may be legallyobliged to target in the interests ofbeneficiaries and which may not
be met if investee enterprises are
exposed to, and are not addressing,wider sustainability risks;

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI(c) an over-dependence on the historic
price and volatility of investments, sothat modern portfolio theory may notcope well with new or unusual factors
such as long-term sustainability risks,a shortcoming highlighted by the 2008
financial crisis and climate change;

active managers assessing fundamental
enterprise value, including potentiallysustainability risk, are supposedly unlikely
consistently to ‘beat the market’).
278(d) the fact that, even if it were correctthat current market prices reflect allavailable information, it is unlikelythat all relevant sustainability
information is currently available tothe market; and(e) the fact that modern portfolio theory
does not address systemic (or ‘nondiversifiable’) risk unless the relevantrisks have been reflected in market
prices – in other words, MPT helps inaddressing the impact on a portfolio ofrisk that is idiosyncratic (ie specific toinvestment in an individual enterprise)and can be ‘diversified away’, butdoes not help in managing the riskspresented by exposure to economic
systems as a whole from factors likeenvironmental and social sustainability.
It essentially assumes that these are
beyond the control of investors.
277

121

The added impetus given by CAPM to theuse of mainstream indices and benchmarksin the investment process helps to embeddynamics of the sort already discussed
in relation to indices and benchmarks(see Section 4.2.2 above). The assumption
underlying the efficient market hypothesis
has also underpinned the move towards
seeking exposure to those benchmarks
through passive investing (on the basis that

In consequence, it seems likely thatthese models and theories could result ininsufficient attention to:(a) sustainability factors that could
be relevant to short- or long-term
investment performance at enterpriselevel (for example, because thosefactors are incorrectly assumed
already to be reflected in the price,because they are entirely novel andare therefore not reflected in past
performance information, or because
they can be ‘diversified away’); and(b) systemic, non-diversifiable, risk which
due to its system-wide nature could domaterial damage across an investment
portfolio and to all portfolios invested
in a given market (since the models do
not address this kind of risk).

279

280

Some of the growth in sustainable
investing can be seen as an attempt
to address the first of these especially.
Common forms of sustainable/responsible
investing involving, essentially, under- or
overweighting investments in enterprises
based on their sustainability profile
may help to address sustainability risks
at investee enterprise level even if they
are not deliberately deployed to pursue
sustainability impact goals (see Part A.1.4).
As regards the second, systemic factors arepotentially some of the most important
determinants of investment return and,as indicated, modern portfolio theory

assumes that these are not manageable
risks. Reliance purely on portfolio theory
may therefore lead investors to fail torecognise the possibility of engaging in
instrumental IFSI (in particular, throughstewardship and public policy work,see Box 6) to address risks of this sort,
so as to discharge investment duties.
Widespread over-reliance on modern
portfolio theory could, ironically, therefore
contribute to the materialisation, or atleast exacerbation, of the very systemicrisks that it assumes cannot be managed
by discouraging investors from attempting
to address wider environmental and social
sustainability factors that will ultimately
damage financial performance.128 Clearly,
systemic risks are system-wide and cannot
necessarily be addressed exclusively by
investors or by individual investors acting
alone (see Part A.2, Box 6). However, inpractice, a growing number of investors
appear to accept that investment processes
can be part of the solution and areengaging in collective action to addresssome of these risks (see Part B.2, Box 2).

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
Box 6
Portfolio diversification, stewardship and public
policy engagement
Portfolio diversification is an important way of
avoiding over-exposure to the risk posed byinvesting in any single enterprise – ie firm-specificrisk. Diversifiable risk is risk that can be managed
or eliminated in this way. Non-diversifiable riskrefers to systemic risk.129 Addressing diversifiablerisk therefore has important implications forinvestment selection within a portfolio. Indeed, themost diversified portfolios are those that track thecomposition of broad-based investment indices,
so that the portfolio is comprised of their multiple
constituent investments.
However, diversification may also influence
investors’ attitudes towards stewardship activity,
especially if it rests on the assumption thatdiversifiable risk is within the control of investors
while non-diversifiable risk is not. The morediversified a portfolio, the less logical it may be toengage in stewardship to secure enterprise specificvalue protection or enhancement. Diversificationis specifically intended to minimise idiosyncratic
impacts on portfolio performance. In addition,
the greater the number of investee enterprises,
the more time-consuming and expensive is the

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

challenge of achieving effective engagement.
These considerations are relevant in deciding what
legal duties require or discretions permit.
Yet diversified portfolios remain exposed to nondiversifiable risks, for example where declining
environmental or social sustainability undermines
the performance of whole markets or sectors.
Even for investors with diversified portfolios,
therefore, they may still need to consider whether
to undertake stewardship, and indeed policy
engagement, with a view to addressing systemicrisks of this sort. Indeed, for investors who are likely
to hold diversified portfolios in the long-term,
the question is particularly pressing since these
are likely to be the main ways in which they may
be able to make a difference.130 Since systemicchange is largely beyond the control of any single
actor, the possibility of collaborating with otherinvestors with the same goals is also an importantconsideration in this (see Part A.2, Box 6 and Part
B.2, Box 2).
In view of this, it is unsurprising that some of theworld’s largest passive investors have become
active in their stewardship activities. Since theportion of global AuM managed by these investors
is already high and looks set to grow further, they
have considerable potential influence.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

122

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THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
1

2

As set out in its founding treaties, the EU is competent to adopt
legally binding rules to exercise its competences, which also cover
the matters relevant for this report. The EU is therefore treated as a
jurisdiction for purposes of this report.
There are some exceptions. For example, Brazilian investment funds
take the form of a ‘condominium’ of assets and, therefore, have nolegal personality. All investment powers and other powers related tothe exercise of ownership rights connected with portfolio assets are
exercised by the investment manager, as provided for by regulation.
The fund’s by-laws and the investment management agreement
can only limit those powers, not grant them, and often do, eg where
the fund’s objective is defined by reference to a particular sort offinancial return for investors.

3

See, for example, Institutional Investors as Owners: Who They Are
and What Do They Do?, OECD, 2013, 9.

4Personal pension plans are frequently structured as insurance
products. For the position in relation to these, see discussion on
insurers.

5

Global Pension Fund Assets Study, Thinking Ahead Institute, Willis
Towers Watson, 2021, 6.

62021 Investment Company Fact Book: A Review of Trends andActivities in the Investment Company Industry, Investment
Company Institute, 61st edn, 2021, 7. Since a portion of the units inthese funds are held by pension funds and insurance undertakings,
there is likely to be some double counting as between this figure
and those for pensions and insurance undertakings.

7

For example, at the end of 2017, pension funds and insurancecompanies held 41.7 per cent of European investment fund units(Ownership of Investment Funds in Europe, Efama, 2019, 12 Fig.
3.2).

8

Some types of life insurance product, such as term life policies,
simply provide for the payment of a certain amount on death during
the term of the policy, and do not constitute a vehicle for savings orinvestment.

910

Global Monitoring Report on Non-Bank Financial Intermediation,
Financial Stability Board, 2020, 13. Again, a portion of these assets
are managed in connection with life contracts entered into withpension funds. Further, in some cases, assets held in connection with
unit-linked insurance policies are invested in mutual funds. There is
therefore potential for double counting.
See, for example Investment Consultants Market Investigation,
Final Report, UK Competition and Markets Authority, 2018, 35, 41;
Scott D. Stewart, Christopher D. Piros and Jeffrey C. Heisler, Portfolio
Management: Theory and Practice (Willey 2019), 270.

11

Investment Consultants Market Investigation, Final Report, UK
Competition and Markets Authority, 2018, 40 f.

12

For example, it has been estimated that in the UK investment
consultants advise on approximately £1.6tn of pension scheme
assets and fiduciary managers manage approximately £110bn of
UK pension scheme AuM (Competition and Markets Authority, Final
Report, Investment Consultants Market Investigation, 2018, 34).

13

Investment Consultants Market Investigation, Final Report, UK
Competition and Markets Authority, 2018, 48.

14UK, France and the Netherlands are much influenced by the EU
regulations, but there are still material local differences.

15

Examples include South Africa, after the end of apartheid and the123

subsequent Broad-Based Black Economic Empowerment legislation;
China and its concept of ‘ecological civilisation’, developed in
the mid-1980s and anchored in Chinese tradition; and the US
where changing policy towards certain sustainability issues, suchas the Paris Climate Agreement, influences the context in whichinvestment powers are exercised.
16

Freshfields Report,13.

17

Balancing Act: Managing Risk across Multiple Time Horizons,
FCLTGlobal, December 2018.

18

19

For example, an investor might perhaps seek to maintain a portfolio
comprised of a mixture of investments focused on the short andlong term, pursuing what is effectively a form of long/short-term
diversification. Similar to the way risk and rewards are balanced ina portfolio in seeking to find an optimal relationship between thetwo depending upon the investor’s need for a financial return andappetite for risk, so a portfolio and broader investment strategy
might also be diversified among short- and long-term rewards andrisks.
For example, the Sustainable Development Investments Asset
Owner Platform established by APG, AustralianSuper, British
Columbia Investment Management and PGGM during 2020 (seehttps://www.pggm.nl/en/press/us-1-trillion-asset-owner-platformlaunches-solution-for-identifying-sdg-investments/, accessed 29
January 2021).

20

Gaia Balp and Giovanni Strampelli, Institutional Investor Collective
Engagements: Non-Activist Cooperation vs Activist Wolf Packs,
Ohio State Business Law Journal, 2020, Vol 14(2), 135.

21

Unhedgeable Risk, Cambridge Institute for Sustainability Leadership2015. More recently, see The Inevitable Policy Response, (available
at https://www.unpri.org/inevitable-policy-response/what-is-theinevitable-policy-response/4787. article, accessed 4 May 2021).

22

See, for example, Elroy Dimson, Oğuzhan Karakaş Xi Li, CoordinatedEngagements, ECGI Finance Working Paper No. 721/2021,
January 2021; Balp and Strampelli, Institutional Investor Collective
Engagements: Non-Activist Cooperation vs Activist Wolf Packs.

23

See https://globalinvestorcoalition.org

24

See https://www.ceres.org

25

See https://www.investorforum.org.uk/wp-content/uploads/
securepdfs/2019/11/The-case-for-collective-engagement-211119.pdf(accessed 2 January 2021)

26

https://www.climateaction100.org

27

https://www.unepfi.org/net-zero-alliance/

28

https://www.netzeroassetmanagers.org

29

https://investorsforhumanrights.org

30

https://www.fairr.org

31

https://gisdalliance.org

32

https://www.imvoconvenanten.nl/en/pension-funds

33

See https://d8g8t13e9vf2o.cloudfront.net/Uploads/r/q/s/
investorstatementondeforestationandforestfiresintheamazon_29_
oct_2019_665598.pdf coordinated by the PRI and Ceres, accessed
21 January 2021.

34

https://www.mirova.com/en/news/European-investors-rally-aroundbiodiversity, accessed 2 January 2021.

35

https://amrinvestoraction.org, accessed 29 January 2021.

36

https://www.churchofengland.org/about/leadership-and-governance/
church-england-pensions-board/old-pensions-board-investments-0

37

https://investorsforhumanrights.org/sites/default/files/
attachments/2020-04/The%20Investor%20Case%20for%20
mHRDD%20-%20FINAL_3.pdf, accessed 2 January 2021.

38

See also Gillian Tett, ‘ESG investors are taking on Big Tech’, Financial
Times, 19 December 2019.

39

See, for example, a recent legal action in Australia taken by apension fund beneficiary against the pension fund (Mark McVeighv Retail Employees Superannuation Pty Ltd CAN 001 987 739(NSD 1333/2018)). In a public statement about the settlement, thepension fund acknowledged that, ‘Climate change is a material,
direct and current financial risk to the superannuation fund across
many risk categories, including investment, market, reputational,
strategic, governance and third-party risks. Accordingly, Rest, as asuperannuation trustee, considers that it is important to actively
identify and manage these issues…’ (see https://rest.com.au/why-rest/
about-rest/news/rest-reaches-settlement-with-mark-mcveigh,accessed 10 November 2020).

40

For example, the UK initiative, Make My Money Matter (https://makemymoneymatter.co.uk/) and in Germany, My Fair Money(https://www.meinfairmögen.de/infomaterial).

41

Quantitative investment is investment driven by quantitative rather
than a qualitative assessment of individual investments. It uses
statistical tools to assess the behaviour of the price of investments
over time. This information is used to create a set of rules for
identifying investments that have an above average likelihood of
outperforming a given benchmark. The portfolio is then invested andperiodically rebalanced in a manner that reflects those rules.
Algorithmic trading is computerised trading where trades areentered into using a programme that follows a set of pre-definedrules or instructions based on mathematical models or otherfactors such as the price, trade size or timing of transactions. While
much algorithmic trading is ‘high-frequency trading’ (where thetrading strategy involves dealing rapidly at scale to profit fromsmall movements in the price of investments) it can also be
used in executing longer-term investment strategies. By contrast,
quantitative trading is not necessarily automated. It nonethelessinvolves transacting on the basis of various quantitative (as comparedwith qualitative) criteria.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM

42

High-frequency trading strategies may leave little scope foraddressing sustainability concerns.

43

For example, in Australia, in 2019, a specific statutory duty
was introduced requiring an APRA-regulated pension trust to‘promote the financial interests of beneficiaries’ (Treasury Laws
Amendment (Improving Accountability and Member Outcomes inSuperannuation Measures No. 1) Act 2019, Section 52(12). In Canada,
The Pensions Benefits Standards Act (British Columbia), SBC 2012, c
30, s 60 (1) refers to ‘financial best interest’.

ANNEXESIn the US, most state laws contain language that require trustees ofpublic pension funds to act in the “sole interest” of the beneficiaries
and a similar rule applies to trustees of private pension andretirement plans governed by the Employee Retirement Income
Security Act of 1974 (“ERISA”). Under this rule, the trustee “has a duty
to the beneficiaries not to be influenced by the interest of any third
person or motives other than the accomplishment of the purposes

REFERENCES

44

GLOSSARYFreshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSIof the trust”. “Interest” has been interpreted by the US Supreme
Court in the context of ERISA plans to mean financial interests. see
Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 420-21 (2014).
In Australia, in 2020, draft legislation (Treasury Laws Amendment(Measures for a Later Sitting) Bill 2020: Best Financial Interest
Obligation) was released to potentially require superannuation funds
to act only in the ‘best financial interest’ of the beneficiaries.
45

First, the legal concept of a fiduciary duty tends to be associatedwith common law rather than civil law jurisdictions. That said, civil
law jurisdictions generally have legal rules covering analogous
situations the purpose of which is broadly similar to fiduciary
duties. Second, even in jurisdictions that do have such a concept,
not all investment relationships are ‘fiduciary’. Third, even wherea relationship is fiduciary (the prime case being the relationshipbetween a trustee and beneficiaries of the trust, the legal vehicle
often used for pension funds in common law jurisdictions), not all of
the duties that attach to the relationship are ‘fiduciary duties’ eventhough they may be owed by someone who is a fiduciary.

46

See for example the prudent person principle that applies in Canada(see section 2.2.6 et seq. of the Canada Report) in the Pensions
Benefits Act.

47

See for example, the statutory prudent person standard in Canada(see section 2.4.3 et seq Canada Report); in Australia, a director
is required to act with a reasonable degree of care and diligenceand in the ‘best interests’ of the company (Subsections 180(1)and 181(1) Corporations Act 2001 Commonwealth). In Brazil,
an officer or director is required to fulfil fiduciary duties to thecompany, including a duty to pursue the company’s interest andobjectives, provided that the social function is satisfied. In China,
a director is required to exercise the professional knowledge, skill
and experiences of a prudent person under similar circumstances(Article 9 of the PRC Securities Investment Funds Law, Articles 147
and 149 of the PRC Company Law; Article 25 of the PRC Trust Law;
Article 929 of the PRC Civil Code). In Japan, a director is required toperform their duties for a company in a loyal manner (Article 355of the Companies Act), a duty which is owed to the company. In
South Africa a director is required to act in the ‘best interests’ of thecompany (Section 76(3) of the Companies Act, 2008). In the UK, a
director must act in the way the director considers ‘in good faith,
would be most likely to promote the success of the company forthe benefit of its members as a whole’ (Section 172(1) Companies
Act 2006). In the US under the ‘business judgment rule’ a court will
uphold the decisions of a director and not second-guess businessjudgments so long as they are made in good faith, with the care thata reasonably prudent person would use and with the reasonable
belief that the director is acting in the ‘best interests’ of thecorporation.

48

For example, see the Australian Supreme court, Australian
Prudential Regulation Authority (APRA) v Kelaher [2019] FCA 1521,
[49].

49

For example, in Australia see ASIC’s Regulatory Guide 128: Collective
Action by Investors, 23 June 2015. In Japan, see section 2 of the“Clarification of Legal Issues Related to the Development of theJapan’s Stewardship Code” (accessible via https://www.fsa.go.jp/en/refer/councils/stewardship/20140226.pdf). In South Africa, see theapproach to collaboration under CRISA. In the UK, see the approachto collaboration under the Stewardship Code 2020.

50

124

European Commission Daily News, 13 October 2020, p. 4 (accessible
via https://ec.europa.eu/commission/presscorner/api/files/document/
print/en/mex_20_1891/MEX_20_1891_EN.pdf).

53

Article 1, Item 1 of the Basic Guideline. The Basic Guideline is also
applicable to Welfare Pension Insurance scheme run by mutual
aid associations; for GPIF, see also ‘Mid-term goals’ Section 3,
Article 7, Provisions 1-2 which are based on the understandingthat sustainable growth of investee companies and the market isnecessary to increase long-term gain by investing pension reserves.

54		Section 3, Item 12 of the Basic Guideline.
55

For example, in the Netherlands, subject to limited exceptions,financial institutions must take adequate measures to ensure thatthey do not invest in companies that produce, sell or distributecluster munitions (Market Abuse (Financial Supervision Act) Decree,
Article 21A).

56		See Gabriel Ondetti, The social function of property, land rights
and social welfare in Brazil. Land Use Policy, Jan. 2016, 29-37,
referring to the social function of ownership in Brazil: ‘The right ofprivate ownership includes an obligation to use property in waysthat contribute to the collective or common good’ and owners are‘obligated to refrain from using their property in ways that harm
others.’
57		Article 12 of the PRC Insurance Funds Equity Investment Measures.
58		Article 1(1) of the Notice of the China Banking and Insurance
Regulatory Commission on Matters concerning the Participation of
Insurance Funds in the Long-term Rental Market.
59		Article 4 of Notice of the General Office of the China Banking andInsurance Regulatory Commission on Matters concerning theInvestment in Collective Trust Funds with Insurance Funds.
60

Article 10 of the Interim Provisions on the Management of Debt
Investment Schemes in Infrastructure Facilities.

61‘Ecological civilization’ has been written into China’s constitution as
the ideological framework for its environmental policies, laws andeducation. In general, this means a new stage in the developmentof human civilization after the current industrial civilization, a sum ofmaterial and spiritual results to be achieved by mankind following
the rule of the harmonious development of man, nature, and society.

62

Articles 86 and 87 of the Code of Corporate Governance of Listed
Companies.

63

Broad Based Black Economic Empowerment Act, 1998 and therelated Codes of Good Practice.

64

Although there are limited ‘hard law’ requirements for private
entities under B-BBEE legislation, from a commercial perspective,
any company wishing to do business in the South African
environment must consider and develop its B-BBEE position as, inaddition to the pressures from government, an entity that does nothave a good B-BBEE rating, or does not strive to improve its B-BBEE
rating, may be hampered in the conduct of its day-to-day businesswith government, organs of state and private sector customers.

65

Regulation 28(2)(c) to the Pension Funds Act 1956.

66

FSCA, Guidance Notice 1 of 2019 on Regulation 28 to the Pension
Funds Act 1956.

67

For example, Canada, South Africa, the US, China.

68

In other words, transparency, solvency, liquidity and financial,

INTRODUCTION

economic and actuarial balance are ensured, as well as the legal
requirements of CMN Resolution No. 4,661/18 and PREVIC Rule No.
6/18 are met.

ACKNOWLEDGEMENTS

69

For example, due to liquidity requirements, in may be challenging
for an insurer to invest significant amounts in illiquid infrastructure or
real estate projects, although some investment in such assets is likely
to be possible.

EXECUTIVE SUMMARY

70

Supreme Court of Canada, BCE Inc. v. 1976 Debentureholders,[2008] 3 SCR 560 [Debentureholders].

71

Supreme Court of Canada, Hodgkinson v Simms, [1994] 3 SCR 377[Simms], para. 419.

72

Cf. Recital 1-3 of Directive (EU) 2017/828 of 17 May 2017 amending
Directive 2007/36/EC as regards the encouragement of long-term
shareholder engagement, OJ L 132, 20.5.2017, 1.

73

CRISA Committee, CRISA Code for Responsible Investment in South
Africa: 2020 Revision Consultation Draft, (available at: https://cdn.
ymaws.com/www.iodsa.co.za/resource/collection/1D7CF73B-B95B453F-A8E3-D19829D18FBD/CRISA_2.0_Draft_for_public_comment.
November2020__00000004_.pdf).

74

See Revised draft CRISA Principle 2 and the practicerecommendations thereunder.

51		These could include, for example, diminution in income from, or tothe market value of, one or more investee companies.
52		CFRF 2020 Guide, Summary chapter 3.

FOREWORDS

75		The FCA has similarly described the purpose of stewardship as to,‘improve market quality and integrity, and help create sustainable,
long-term value for clients and beneficiaries. Effective stewardshipis also expected to have wider economic, environmental andsocietal benefits.’ (Building a regulatory framework for effective
stewardship, FCA, Feedback Statement FS19/7, 2019, para. 1.1).
76		Principle 10, The UK Stewardship Code 2020, Financial Reporting
Council, 2020, 19.
77

Guidance 1-1 regarding Principle 1 of the Code.

78

Guidance 4-5 regarding Principle 4 of the Stewardship
Code (accessible via https://www.fsa.go.jp/en/refer/councils/
stewardship/20200324/01.pdf).

79

As regards mutual funds, BlackRock, State Street Global Advisors
and Vanguard Group are among the most significant in the US, bothin terms of size of investments and stewardship influence. Eachcompany releases stewardship reports, detailing its respective focus
and efforts on stewardship with companies. BlackRock has been
vocal about its view that sustainability considerations are inseparablefrom its role as a fiduciary to its clients’ assets due to BlackRock’sview that these issues drive long-term sustainable performance.
State Street has declared that it believes stewardship is a fiduciary
responsibility and one of the ways State Street can add value toportfolio companies and clients. Vanguard disclosed that it raised
relevant environmental and social issues at companies across avariety of sectors and regularly asks companies how the company’ssustainability strategy integrates with corporate strategy. These
institutions link sustainability objectives to improved economic
return (see US Report for details).

80

See Section 3, Article 7.1 of the Mid Term Goals.

81

The Australian analysis considers registered and managed
investment schemes and listed investment companies.

82

Anecdotally, the hearings conducted by the Royal Commission into
Misconduct in the Banking, Superannuation and Financial Services
Industry were seen as contributing to severe reputational damage
for Australia’s major banks, and their subsidiaries that are APRA-

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
regulated trustees, which resulted in significant outflows from theirsuperannuation funds.
83		For example, Our Partnership for Sustainable Capital Markets,
Government Pension Investment Fund, March 2020 (accessible
via https://www.gpif.go.jp/en/investment/Our_Partnership_for_
Sustainable_Capital_Markets.pdf).
84

85

86

87

88

125

For example, in the UK guidance from The Pensions Regulator for
defined contribution trust-based pensions schemes provides thatpension trustees should, ‘consider how engagement could be used
to mitigate systemic, macro-economic risks such as climate change’
and pension trustees, ‘may need to take action to ensure that [their]
policies are being applied; possibly including active public policy
engagement, collaborative initiatives and advocacy’, TPR, Investment
Governance (accessible via https://www.thepensionsregulator.gov.uk/
en/trustees/managing-dc-benefits/investment-guide-for-dc-pensionschemes). The guidance goes on to provide an example of language
for a trustee’s statement of investment principles which sets out
in relation to the consideration of climate change as a financial
factor: ‘given the systemic nature of climate change, we will alsoseek to discharge our duties by robust engagement with investee
companies to encourage alignment with a low carbon economy andwith policy-makers and governments to advocate for the same.’See for a recent discussion about whether it is appropriate for
APRA-regulated pension trustees to engage in lobbying and policy
discussions in relation to climate change risks; Joanna Mather, ‘Put
members’ returns ahead of activism, Samuel tells super funds’,
Australian Financial Review (online), 11 September 2019 (accessible
via https://www.afr.com/companies/financial-services/put-membersreturns-ahead-of-activism-samuel-tells-super-funds-20190911p52q7l)..
Note that Asset Owners may have multiple Investment Managers, sothat this would not necessarily preclude an Asset Owner appointing
a manager to invest a portion of its assets in a sustainability
impact strategy, such as investments in impact funds, based ondiversification benefit.
Asset owners sometimes access the investment expertise of aninvestment manager by acquiring units in a fund managed by thatinvestment manager or by entering into a life policy the supporting
assets of which are managed by the investment manager, rather
than appointing the manager to manage a segregated portfolio.
Where that happens, the asset owner needs to consider whether theinterposition of this additional legal structure could adversely impact
the ability of the manager to assist it in achieving any sustainability
impact goals (since the investment manager will owe its duties tothe relevant investment fund or life company and not to the asset
owner).
For example, in the EU, see ESMA Guidelines on certain aspectsof the MiFID II suitability requirements (2018), para. 28, and also
statement from the European Commission that firms ‘Should ask
about their clients’ preferences (such as environmental, social andgovernance factors) and take them into account when assessing
the range of financial instruments and insurance products to berecommended.’ In South Africa, the voluntary Code for Responsible
Investing in South Africa (CRISA) recommends that institutional
investors and investment managers (as service providers, ‘shouldincorporate sustainability considerations, including ESG, into its
investment analysis and investment activities as part of the deliveryof superior risk-adjusted returns to the ultimate beneficiaries’ (CRISA,
principle 1). In the UK, see the Investment Association’s Responsible
Investment Framework.

89

See MiFID II Sustainability Delegated Regulation.

90

ESMA, Guidelines on certain aspects of the MiFID II suitability
requirements, 6 November 2018, ESMA35-43-1163; para. 28.

91

See MiFID II Sustainability Delegated Regulation.

92

On the related question of lender liability see Lenders and Investors
Environmental Liability – How Much is Too Much, UNEP Inquiry
Working Paper 16/07, April 2016, with a discussion of investor liability
at p. 22 et seq.

93

The reason this aspect is relevant is that were potential liability toexist this could provide a justification for instrumental IFSI where theinvestment portfolio might be exposed to this.

94

For example, Australia, South Africa, the UK.

95

For example, Brazil (generally only for individuals, but exceptions forenvironmental crimes).

96

For example, in South Africa, such criminal liability is provided for inseveral laws (Section 49 of the National Environmental Management
Act, 1998; Section 151(1) of the National Water Act, 1998; sections 51
and 52 of the National Environmental Management: Air Quality Act,
2004; section 67 of the Hazardous Substances Act, 1973; and theAsbestos Prohibition Regulations).

97

In this context, the concept of (piercing the) corporate veil mightalso be relevant in many jurisdictions, which generally sets highthresholds for shareholders to assume civil liability for actions of theinvestee company.

98

The Hague District Court 26 May 2021, Friends of the Earth andothers v. Royal Dutch Shell plc, (ECLI:NL:RBDHA:2021:5337 and
ECLI:NL:RBDHA:2021:5339); (accessible via https://uitspraken.
rechtspraak.nl/inziendocument?id=ECLI:NL:RBDHA:2021:5339)

99

Supreme Court of the Netherlands, Urgenda Foundation
v. Government of the Netherlands, 20 December 2019,
ECLI:NL:HR:2019:2006.

100

The NEMA allows a person or group of persons to seek appropriate
relief for any breach or threatened breach of statutes concernedwith environmental protection or the use of natural resources,
whether in their own interest, the public interest, the interest of aclass of persons (class actions are recognised in South Africa), or in
the interests of the environment itself. Section 32 of NEMA provides
for locus standi in respect of any breach or threatened breachof any statutory provision concerned with the protection of theenvironment or the use of natural resources. A similar duty of careapplies under the National Water Act, 36 of 1998 in relation to waterpollution.

101		These include where a parent company issues ‘[g]roup guidelines
about minimising the environmental impact of inherently
dangerous activities […] contain[ing] systemic errors which, when
implemented as of course by a particular subsidiary, then cause
harm to third parties.’
102		Supreme Court of the United Kingdom, Caparo Industries PLC v
Dickman [1990], UKHL 2, [1990], 2 AC 605.
103		Where an Asset Owner is involved directly in lending activity (socalled ‘shadow banking’), there may be a closer nexus between the
Asset Owner (as lender) and the activities of the investee company,
which may have a negative sustainability impact. This may increase
the possibility of a successful claim in negligence – for example,
where a loan for a particular activity which ultimately caused anegative sustainability impact was given negligently, on the basis

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

that it was reasonably foreseeable that the activity for which the loan
was granted would result in a negative sustainability impact.
104

In Brazil, administrative liability is enforced by administrative entities
through the application of sanctions, such as fines, partial or totalsuspension of activities, forfeiture or restriction of tax incentives orbenefits, and forfeiture or suspension of credit lines made available
by official credit establishments. Remediation measures are usually
addressed in the civil liability sphere, in which private or public
entities could claim for that against the polluter.

105

Directive 2004/35/EC of the European Parliament and the Councilof 21 April 2004 on environmental liability with regard to theprevention and remedying of environmental damage, OJ L 143, 5675.

106

Article 1 ELD. The polluter-pays principle is part of EU primary law,see article 191(2) TFEU: ‘Union policy on the environment […] shallbe based on the precautionary principle and on the principles thatpreventive action should be taken, that environmental damage
should as a priority be rectified at source and that the polluter
should pay.’107

Articles 6 to 9 Environment Liability Directive.

108

Article 3(3) Environment Liability Directive.

109

Article 2(6) Environment Liability Directive.

1.

Methodology

110

On the possibility of a broad interpretation of the term ‘operator’,see the Study on Environmental Liability of Companies, May 2020,
commissioned by the European Parliament’s Policy Department for
Citizens’ Rights and Constitutional Affairs, 31 et seq.; Lenders andInvestors Environmental Liability – How Much is Too Much, UNEP
Inquiry Working Paper 16/07, April 2016, 6 and 22; Lucas Bergkamp,
The Environmental Liability Directive and Liability of Parent
Companies for Damage Caused by Their Subsidiaries, European
Company Law, 2016, Vol. 13(5), 183-190, 184 et seq.

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

111

Cf. National Contact Point, ‘View a closed complaint’, 15 July
2020 accessible via https://ausncp.gov.au/complaints/view-closedcomplaint).

4.

112

For example, OECD Watch Case Database, EC and IDI v Australia
and New Zealand Banking Group, 6 October 2014 (accessible via
https://www.oecdwatch.org/complaint/ec-and-idi-vs-australia-andnew-zealand-banking-group).

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

113

OECD Watch Case Database, Milieudefensie et al. vs. ING, 5 July
2019 (accessible via https://complaints.oecdwatch.org/cases/
Case_543).

114

OECD WatchCase Database, Milieudefensie et al. vs Rabobank,
15 January 2016 (accessible via https://www.oecdguidelines.nl/
documents /publication/ 2016/1/15/fs-foe-milieudefensie-rabobank).

115

National Contact Point for the OECD Guidelines for Multinational
Enterprises, Milieudefensie et al. vs. ING, 20 January 2019(accessible via https://www.oesorichtlijnen.nl/documenten/
publicatie/2020/01/20/initial-assesment-friends-of-the-earth-vs.-ing).

116

https://www.fsb-tcfd.org

117

Based on the Oxford English Dictionary definitions.

118

See, for example, the EU Capital Markets Action Plan
(Communication from the Commission to the European Parliament,
the Council, the European Economic and Social Committee and theCommittee of the Regions, A Capital Markets Union for people andbusinesses – new action plan, European Commission, COM(2020)

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

THE EXTENT TO WHICH THE LAWREQUIRES OR PERMITS IFSI
590 final, Brussels 24 September 2020) and associated workstreams.
In the case of equity investment, see The Kay Review of UK Equity
Markets and Long-Term Decision Making, Interim Report, February
2012 and Final Report, July 2012 (available at https://assets.
publishing.service.gov.uk/government/uploads/system/uploads/
attachment_data/file/31544/12-631-kay-review-of-equity-marketsinterim-report.pdf and https://assets.publishing.service.gov.uk/
government/uploads/system/uploads/attachment_data/file/253454/
bis-12-917-kay-review-of-equity-markets-final-report.pdf, accessed
11 December 2020). These reports were focused on the UK equities
markets. Steps have been taken in the UK to seek to address theissues identified, but they have not entirely resolved them.
119

For evidence of extent to which time horizons diverge between asset
owners and their managers, see The Investment Enlightenment,
State Street Corporation 2017, especially 21-23.

120

See, for example, The future for business investment in the age of
Covid and the role of financial services, speech by Andrew Bailey,
Governor of the Bank of England, 17 November 2020.

121

See, for example, The Kay Review of UK Equity Markets and LongTerm Decision Making.

122

See, for example, New Frontiers of Risk: Revisiting the 360°
Manager, BNY Mellon, 2014 (available at https://fundspeoplerepository.s3.amazonaws.com/system/audio_document/file/122/
a8c1035313addf2d.pdf, accessed 8 January 2021); Mark Rubinstein,Markowitz’s ‘Portfolio Selection’: A Fifty-Year Retrospective, Journalof Finance, 2002, Vol. 57(3), 1041-1045; Zvi Bodie, Alex Kane andAlan J. Marcus, Investments, 12th Edn (McGraw Hill), 275.

123

Starting with Harry Markowitz, Portfolio Selection, Journal of Finance
1952, Vol. 7(1), 77-91.

124

Zvi Bodie, Alex Kane and Alan J. Marcus, Investments, 12th Edn(McGraw Hill 2021), G-4.

125

In the words of Alan Greenspan, ‘… the models failed at a time when
we needed them most … To me it suddenly seemed that the wholeidea of taking the maths as the basis of pricing that system failed.
The whole structure of risk evaluation – what they call the ‘Harry
Markowitz approach’ – failed…’: Gillian Tett, ‘An interview with Alan
Greenspan’, Financial Times, 25 October 2012.

126

We are not the first to pick this up. See, for example, The Kay Reviewof UK Equity Markets and Long-Term Decision Making, 34

127

Portfolio theory takes the ‘market portfolio’ as minimising the tradeoff between risk and return. The market portfolio is the portfolio
comprising all assets in the investible universe in which each asset
is held in proportion to the market value of the investment (priceper share multiplied by the number of shares outstanding) divided
by the sum of the market value of all investments in the investible
universe: Zvi Bodie, Alex Kane and Alan J. Marcus, Investments,
12th Edn (McGraw Hill 2021), 277. However, there is no easy way torepresent this for modelling purposes, so broad-based capitalisation
weighted indices are used instead.

128

Steve Lydenberg, Integrating Systemic Risk into Modern Portfolio
Theory and Practice, Journal of Applied Corporate Finance, 2016,Vol 28(2), 56-61.

129

As noted in Part A.1, Box 4, these risks are sometimes referred to as
being systematic. However, usage has not been standardised acrossdifferent disciplines and so in this report we are using the word
‘systemic’.

130

Jeffrey N. Gordon, Systematic Stewardship, ECGI Law Working Paper
No. 566/2021, February 2021.

FOREWORDSINTRODUCTIONACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIINTRODUCTION
1.

Methodology

2.

Investing for sustainability
impact: different legal regimes but
common themes

3.

IFSI in eleven jurisdictions - Summary offindings

4.

Do existing market features
create a risk that sustainability
factors are given insufficient weightby investors in complying with legal
duties?

C. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

126

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AREAS FOR LEGAL REFORMFOREWORDSINTRODUCTIONINTRODUCTION
1

2

We have been asked to comment on
options for policymakers1 wishing tofacilitate IFSI.

ACKNOWLEDGEMENTS

to facilitate IFSI is not just political but has
legal implications.
5

In what follows:that investment arrangements of thesort covered by this report achieve theirfinancial goals, and to secure financial
and economic goals relevant to theirjurisdiction; andimpediments to IFSI which policy
measures might address; and• Section 2 outlines possible options.

Investment markets are complex. Theinterconnections between them, theeconomy, wider society and overarchingsustainability outcomes are deep andmulti-layered. In addition, each jurisdictionis unique. Because of that, any policy
intervention would require situationspecific assessment and consultation goingwell beyond the scope of this exercise. It
is therefore important to emphasise that
Section 2 provides no more than a highlevel indication of options that may be
worth consideration, not proposals. It isalso not exhaustive.

We have assumed that policymakers:• are likely to intervene to help ensure• Section 1 summarises potential

3• will often be motivated to intervene

to achieve overarching sustainability
outcomes, consistent with international
commitments and legal undertakings
and wider social values.
6This echoes the distinction between
instrumental and ultimate ends IFSI madein this report concerning investors’ goals.
Policy responses to both categories could
make use of both sorts of IFSI, exceptthat steps to ensure that investment
arrangements meet their financial goals
would probably be largely confined to
instrumental IFSI.

Policymakers’ goals and the impact onlegal rules

Why public policy intervention might be needed

4

7

127

Where policymakers decide to intervene,
they need to make their purpose clear.
The importance of clarity about the goalof investment activity has been a key
theme in this report. It is similar with
policy. The overarching purpose of policy
intervention drives a host of subsequentdecisions, for example, in selecting areas
for intervention and the means for doing
so. In many jurisdictions, the purpose of alegal rule will also be taken into accountin its judicial or regulatory interpretation,with obligations interpreted in the light ofthe purpose of the overall legal frameworkof which they are a part.2 Hence, thequestion of why policymakers would wantdelivery of a desirable outcome, but thefact that it is not fully within the capacityof a market to do so. Further, economically
optimal outcomes are not always thosethat societies ultimately value most highly,
even where economic wellbeing is integral
to those broader goals.

From an economic perspective, the casefor policy intervention tends to be viewed
through the lens of ‘market failure’.
Market failure describes a situation where
the result of individuals acting rationallyin their financial or material self-interest
is not consistent with a rationally optimal
outcome for the group. The market failure
framework is a powerful and extensively
used theoretical tool for deciding whenintervention is needed and certainly
provides a justification for intervention in
relation to some sustainability challenges.
However, even markets have their limits; it
may not be ‘failure’ that prevents market

8

Other reasons why policy intervention
might be needed include:• the challenge of balancing the social

implications of pursuing or not pursuingoverarching sustainability outcomes,
since these raise questions of justicethat need to be resolved throughpolitical processes (for example, should
beneficiaries’ financial returns ever be
put at risk?), see Box 1;• the systemic nature of manysustainability challenges, making somedegree of coordination and cooperationnecessary to address them. Coordination
can be provided privately and Part B2,
Box 2 considered the many collective
investor initiatives now under way to dothat. However, the other main source ispublic policy;

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES• the fact that institutional investors often

operate through legal entities (such ascompanies) that have been constitutedand defined by law, the characteristics ofwhich can therefore only be changed bylaw, and the fact that some benefit frompublic fiscal or other support, making
them, and what activities are within
their capacity, partly the product andconcern of public policy.3

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Box 1: Institutional investment and coresocial goals
The issue of whether institutional investors should
pursue sustainability impact goals beyond those
relevant to discharging investors’ duties in relation
to financial return (ie instrumental IFSI), raises
important policy questions about how to achieve
outcomes aligned with core social values.
Institutional investors operate within a wider social
context. The question of how far societies should
pursue overarching sustainability outcomes, andthe role of institutional investors in that, is not one
that institutional investors can answer on theirown. Ultimately, it requires resolution by thosesocieties through a political process, and justicedescribes an appropriate balance between varying
needs and interests. Whatever the answer, there
could be implications, financial and otherwise,for beneficiaries, those within the societies andbeyond, and future generations.
Pursuing one set of sustainability goals (forexample, tackling water scarcity so as to avoid
political and social unrest) may affect how far
the goals of others can be realised (for example,
those reliant upon the short-term profitability ofcompanies that are causing resource depletion).
Both deciding to pursue a given sustainability goal
and not doing so, intentionally or by default, havepotential consequences. In that sense, there is no‘neutral’.
The role of institutional investors in achieving
overarching sustainability goals concerns therelationship between them and their beneficiaries
on the one hand, and those in wider societyon the other. It potentially involves balancing
financial and other socially valued goals. How
people are to support themselves financially isitself a sustainability issue, but so is the wider
environmental and social state of the world inwhich they will do so and in which, more widely,people and institutions must operate. It may
be possible to place a monetary value on some128

sustainability outcomes in trying to balance theseneeds. Certainly, many have financial implications.
However, the value of positive sustainability
outcomes ultimately rests in the life that depends
on them and is not solely financial.
Coming back to the question posed at the startof this report, what is the role or purpose of
institutional investment in all this? For example:• Should investors be expected to contributeto achieving socially valued goals beyond thefinancial benefits they provide?
• How far should investors be permitted to earna financial return from economic activities
which may not be aligned with overarchingsustainability outcomes? For example, should
investment be in some way conditional uponan enterprise progressively aligning withoverarching sustainability outcomes (and, if so,to what extent and which outcomes), and if that
led to reduced financial returns for beneficiaries,
would that ever be acceptable?
• Where investors are required or permitted topursue sustainability impact goals:– Should it be subject to prioritising existing
financial goals?
– Would it be acceptable for an investor toincur heightened financial risks to pursue
sustainability impact goals, and if so, in whatcircumstances, what level of risk, and how is
the risk to be determined?

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES– Which sustainability goals should be covered
and how are they to be determined?
– Are some sustainability goals so importantas to justify putting beneficiaries at greater
financial risk by requiring investors to
pursue them?
• Policymakers wishing investors to pursue
sustainability goals as ends in themselves would
need to consider facilitating some form ofultimate ends IFSI.

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1.

POTENTIAL IMPEDIMENTS TO IFSI INVESTMENT APPROACHES

9

Before looking at policy options, it
is useful to summarise some of thepotential impediments to IFSI investment
approaches highlighted in this report.
That is not least because, as noted, theoptions in Section 2 are not exhaustive,
making it important for policymakers tounderstand the underlying issues so thatthey can consider whether there may be
additional options. The precise natureof any impediments varies dependingon the jurisdiction, the sort of investor
and investment activity concerned, andthe features of the relevant investment
arrangement. However, we have identified
some common factors which may preventor deter investors from adopting IFSI
investment approaches. They fall into thefollowing broad groups:• potential for confusion over the substance• market features that may leadto sustainability factors being
underweighted; and• limited track record for IFSI

investment approaches.
1.1

Limits arising from legal rules oninvestors’ powers and duties

10

Legal rules concerning investors’ powers
and duties may prevent or deter investors
in various ways from engaging in IFSI.

1.1.1

Scope of basic duties – are they broad
enough to allow for IFSI?

11

Investors’ investment duties, andassociated duties such as requirements
to act in beneficiaries’ best interests, arenearly always based on the premise thatinvestors’ primary, if not sole, objective isfinancial. This may lead them to pursue
sustainability goals within the scope of
instrumental IFSI but leaves little roomfor ultimate ends IFSI unless the law also
requires or permits investors to pursue
sustainability impact goals more broadly.4
See Part B.3.2.1.

investors’ powers and duties;• lack of clarity or understanding about

what the law requires or permits;• possible impediments to collective action;• lack of ‘market infrastructure’ forimpact goal setting and assessment,
including investee companies’ disclosure
obligations;
between achieving financial return andsustainability impact;• uncertainty about what beneficiaries want;• lack of suitable investment

opportunities;

129

13

of different forms of sustainable investing
to undermine confidence in IFSIorientated investment approaches;• limits arising from legal rules on• challenges of navigating the relationship

ACKNOWLEDGEMENTS

12

There has been a growth in legislative,
regulatory and industry initiatives that arepotentially relevant to whether investors
can engage in IFSI. However, they tend
not to address specifically the underlying
question of whether investors have a legal
duty or discretion to do so.

For example, a number of recent initiatives
concern disclosure of sustainability
information by investors, such as theirsustainability policies or the sustainability
impact of their activities. This may beon the assumption that transparency
can help to correct market failures, orthat disclosure can ‘nudge’ investors to
pay greater attention to sustainability
factors in their investment process.
Nudges of this sort can be effective inencouraging change, but do not establish
or, in themselves, change, legal duties anddiscretions. IFSI is not possible if investors’
duties and discretions are not broad
enough to allow it.

1.1.2

Legal standards do not encourage
innovative approaches

14

The standard of care investors must
apply in performing their duties is often
linked to the standard of a ‘reasonable’or ‘prudent’ investor, which tends to bereferenced, at least in part, to acceptedmarket practice (see Part B.3.2.2 and 4,
Box 5). Because of that, these standards areinevitably somewhat backward-looking;this could tend to discourage someinvestors from stepping too far ‘out of thebox’ or taking more innovative approaches.

1.1.3

Prudential regulation and financial
reporting

15

The requirements of prudential regulationand financial reporting may create limits,
at least in using investment powers
to pursue sustainability impact goals.
Pension funds and insurance companies

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

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in many jurisdictions are subject to strict
accounting and valuation rules that canbe a significant disincentive to making,or even prevent, investments that are notliquid, or which are difficult to value in the
short term.5
1.1.4

Existing product terms governinginvestment powers

16

Particularly with regulated mutual
funds and investment-related insurance
contracts, the terms of existingarrangements may have been draftedwith little reference to the possibility of
pursuing sustainability impact goals orthat beneficiaries might want this. In
principle, product terms can usually beamended to allow for greater flexibility.
However, doing so is likely to be onerous,
requiring the consent of a significant
proportion, if not all, beneficiaries so that
product providers are likely to be reluctant
to try. See Part B.3.3.1(c).

1.1.5

17

130

Cultural and political expectations
concerning policy engagement byinvestors
In some jurisdictions, the cultural andpolitical context in which investors operate
may lead them to understand their duties
in ways that may limit their public policy
engagement on sustainability issues. See
Part B.3.5.

1.2

Lack of clarity or limited
understanding about what the law
requires or permits

1.2.1

Uncertainty generally

18

Despite the focus on financial returns noted
above, it is clear from our assessment:

20• that there are likely to be circumstancesin which the law may lead an investor toact in a way that falls within the scope of
IFSI to discharge its duties, in particularwhere this is reasonably necessary topreserve the value of a portfolio or
generate financial return; and1.2.2

Collective action and the causal link to
an investor’s actions

21

Many sustainability challenges result
from the activities of a multitude ofdifferent actors and require action frommany different parties to resolve them(see Part A.2, Box 6). Collective action
by investors and between investors andother third parties to secure sustainability
impacts may therefore be important inadvancing solutions.

• that in some cases investors havea degree of discretion to pursue
sustainability impact goals for reasons
other than financial return, usually as asecondary objective.
19

There has been considerable attention to theintegration of ESG factors in the investment
process, where these are material financial
considerations.6 However, that has tended tofocus on using investment powers to avoid
exposure to companies with elevated ESG
risks. Generally, investors and their advisers
seem not to have devoted the same attention
to whether they may be able to influence thesustainability impacts of third parties andhow that might relate to the discharge of
their duties. Investors may therefore be lessconversant with the circumstances in which
duties to exercise an influence could arise orwithin which discretions may be exercised,or even be aware that such circumstances
exist. That could result in hesitancy inadopting IFSI approaches.

Furthermore, the applicable legal rules
have often developed and been appliedwith a primary focus on investment
allocation and selection. Their application
to stewardship activities, public policy
engagement and investor participationin collective action in all spheres of theiractivities has received less attention.

22

23

Where investors, and potentially otherthird parties, are acting in a coordinated
way to achieve sustainability impacts
consistent with those sought by aparticular investor, this can increase thelikelihood of success and reduce the cost of
pursuing them, both of which are likely toweigh in favour of a decision to act.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

Part A.2, Box 6 looked at how courts could
be expected to approach participation in
activities of this sort. Nonetheless someinvestors may still have questions as towhen cooperation with other investors andthird parties is appropriate.

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1.3

Possible impediments to collective
action24

In all jurisdictions there is scope forinvestors to work together to achievesustainability impact goals. In doing sothey need to comply with various rules oncollective action to influence or control
the activities of business enterprises,
for example, takeover rules on acting inconcert and competition law. Information
investors receive as a result of collective
activities may also sometimes be pricesensitive so that it must be handled inaccordance with insider dealing rules.

25

Most collective action of the sort carried on
at present can operate effectively withinthese rules as currently understood, andregulators in most jurisdictions havemade reassuring statements to that effect.
However, the more far-reaching collective
investor action becomes the greater the
possibility that it could affect the markets
for certain goods and services with somepotential for antitrust regulations, inparticular, to be engaged. There are signs
that competition regulators recognise theneed for antitrust regimes not to inhibit
activities that are legitimately designed
to avert systemic sustainability risks.
However, at present antitrust regulations
do not generally include ‘safe harbours’ foractivities of this sort.

1.4

Lack of ‘market infrastructure’ forimpact goal-setting and assessment

26

Part A.1.2.1 discussed definitional
challenges around the concept of‘sustainability’. Part A.2 looked at the
emergent nature of available frameworks

131

for setting sustainability impact goals andthe difficulties of assessing the impact
of businesses and other third parties on
overarching sustainability outcomes.
Part A.2 also looked at how investors
are to understand or measure theirown contribution in achieving a goal oroutcome, especially in view of the collective
dimension to many sustainability challenges(as to which, see Section 1.2.2, above).
27

1.5

beneficiaries is unfairly disadvantaged
if IFSI activity reduces investment
return (as, for example, might be thecase where investees are encouraged by
Asset Owners to transition away from
activities that are causing biodiversity loss
if that weakens the return on relevant
investments). The challenge of setting
this balance could deter Asset Owners
from engaging in investment approaches
within the scope of IFSI, notwithstanding
potential implications for beneficiaries
whose interests might otherwise be better
protected. That said, as noted previously,
the risks to portfolio performance createdby sustainability factors can also crystallise
in the short-term, and institutional
investors are used to balancing shorterand longer-term financial goals so thatvarious approaches may be available tomanage this issue (see Part B.2, Box 1).

As noted in Part A.2, these limitations
make it likely that investors pursuingsustainability impacts will focus onareas, such as climate change, where thenecessary infrastructure is more complete,neglecting those where it is less developed.
Challenges of navigating therelationship between achieving
financial return and sustainability
impactACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

1.5.1

Financial return in the short- andlong-term

1.6

ANNEXES28

Many, if not most, Asset Owners have
duties to generate financial returns overthe long-term, and the risks posed bysustainability factors could be particularly
significant in this context. However, often
they also have duties to generate shortterm returns, particularly where there aredifferent generations of beneficiaries.

Financial return and sustainability
impact30

Where an investor has discretion to seek
to achieve sustainability impacts but muststill prioritise financial return, it may bechallenging to establish with confidence inadvance the possible impact on financial
performance of pursuing a sustainability
impact goal.

GLOSSARY

29

IFSI investment approaches may, inprinciple, be an effective response toprotecting financial performance fromrisks created by sustainability factors.
However, Asset Owners generally needto discharge their duties to all categories
of beneficiaries, so that no generation of

31

REFERENCES

Weighing the benefit of pursuing a given
sustainability impact goal against thepossible effects on financial performancein the short or long term may not be
straightforward.7 Among other things, thevalue of achieving sustainability goals does
not necessarily easily reduce to monetarymeasures and the challenges of defining

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and assessing progress towards them wasnoted in Part A.2, Box 4.
1.6.1

Uncertainty about what beneficiaries
want

32

In some jurisdictions, Asset Owners havesome discretion to engage in ultimate
ends IFSI activities where this reflects
beneficiaries’ preferences (see Part
B.3.3.2(c)). There is growing experience ofassessing these. Nonetheless, some may
feel it is too challenging or expensive to doso effectively.

33

It may also be unclear to Asset Owners
what proportion of beneficiaries must
share a particular view before they canact on it, how to deal with differing
beneficiary sustainability preferences, andhow far beneficiaries would be willing tosacrifice returns to pursue sustainability
impact goals.

1.6.2

Lack of suitable investment
opportunities

34

Some investors might make more useof their investment powers to pursue
sustainability impact goals if more suitable
investment opportunities were available.8

1.7

Market discipline and investor
confidence in the light of uncertainty
over different sorts of sustainable
investing

35

Part A.1.4 looked at uncertainties overwhat different sorts of sustainable
investing involve and how they aredescribed. It particularly highlighted thedifference between:

132• investment approaches that involve

under- or overweighting investee
enterprises based on the extent to which
the enterprises are exposed to or takeaccount of sustainability factors (butwith no explicit intention to change how
they are run); andpursuing sustainability impact. If so,
those considering investment in products
designed to achieve sustainability
impacts could be deterred from doing so,
dampening demand.
1.8

Market features that may leadto sustainability factors being
underweighted

38

Part B.4 highlighted various ways in which
existing market features may:

• those that fall within the scope of IFSI

because they involve intentionallyseeking assessable change in thesustainability impact of those enterprises
or relevant third parties.
36

37

This difference is not well recognised.
Some beneficiaries may therefore currently
believe that their investment is being
managed in ways that fall within thescope of IFSI, when that is not the case,and investors who want their money to be
deployed in achieving sustainability impact
goals may find it difficult to identify
appropriate products. In consequence,
market discipline may not be working
as effectively as it might to ensure that
product providers apply a rigorous andtransparent approach in the way they
pursue sustainability impact goals anddescribe the goals of their sustainability
products. It may also mean that the use of
IFSI investment approaches is not receiving
adequate attention from regulators anddecision-makers in the investment chain.
In view of the different ways in whichinvestors may seek to achieve sustainability
impact goals and address the kind of
infrastructure challenges describedin Part A.2, it may also be difficult tounderstand and compare investment
arrangements that are presented as• result in sustainability factors being

underweighted in the investment
process, so that investors may be lessinclined to adopt any form of sustainable
investing, including those within thescope of IFSI; and• focus investor attention on decisions

concerning portfolio composition, andaway from use of stewardship and public
policy engagement, both of which havebeen identified as potentially importantways of securing sustainability
impact goals.
39

Among the factors highlighted were lackof transparency and uncertainty about the
impact of sustainability factors on investee
enterprises (also part of the ‘infrastructure’issue highlighted at Section 1.4 above), thebenchmarks, investment time horizons
and periods used to measure investment
performance, issues arising from theintermediation of the investment process(including the structure of relationships
between asset owners and investment
managers) and the impact of ‘portfolio
theory’ (which, as the name suggests,
may concentrate attention on the use of

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

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diversification to manage investment risk
at portfolio level, but neglect market-widerisks posed by systemic factors which are
non-diversifiable).
40

41

There may be pressures on asset owners
to prioritise securing a financial returnfor near-term beneficiaries, for example,
as a result of the profile of their funds
or because those beneficiaries might bemore likely to claim against asset owners
if their investment returns are reduced or
threatened. That said, there is also evidenceof pressures on asset owners to take alonger-term perspective, including, forexample, publicity campaigns,9 shareholder
resolutions and even litigation.10
In addition, although many asset owners
purport to be reflecting a longer-term viewin the terms on which they appoint theirinvestment managers, typical mandate
lengths and remuneration structures may

nonetheless create incentives for managers
to focus on shorter-term financial
performance. This may draw attention
away from sustainability factors that areperceived to be longer-term.
1.9

Limited track record for IFSI
investment approaches

42

Investors are likely to feel more confident
about some of the issues highlighted
above if they can identify other investors
with an established track record and findexamples of market practice (see Part B.4,
Box 5). The growing number of collective
initiatives by investors (see Part B.2, Box2) may help to provide that. However,investors seeking to use IFSI investment
approaches could still feel exposed were
their funds also to experience short-termcosts or underperformance.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

133

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2.

REFORM OPTIONS

2.1

Introduction to reform options

43

This section outlines options that thosewishing to facilitate IFSI could consider.
As noted above, it is not exhaustive. Nordoes it cover every area of impedimenthighlighted in Section 1, above. There has
already been relevant policy activity insome jurisdictions. Some of the options
draw on that.

44

45

ACKNOWLEDGEMENTS

to IFSI investment approaches (Section
2.5 below).
46

Since sustainability challenges are often
systemic and international, the impact ofpolicy change is likely to be heightened
if policymakers can coordinate theiractivities to ensure, as far as practicable,
a harmonised international approach.
Coordination may also be needed ata national level between regulators
responsible for different categories
of institutional investor, to ensure a
consistent approach.
Options have been grouped into thefollowing categories:

What legal rules require or permit:the ‘black letter’ of legal rules and thecircumstances in which they are followed– policy implications

47• those that concern clarifying andchanging the scope of investors’ duties
and discretions or the legal frameworks
within which investors must operate(Section 2.2 below);• steps to build the ‘infrastructure’ for IFSI

investment approaches (Section 2.3 below);• steps to influence aspects of investment

markets which may affect the likelihoodof investors adopting IFSI investment
approaches (Section 2.4 below); and• steps to enhance transparency andstrengthen market discipline in relation

134

Nonetheless, many of the options areinterlinked. For example, if there wasan effective, globally accepted, way toassess the progress of an enterprise inaddressing sustainability challenges, andthe valuation impact of sustainability
factors, these might be expected to be
more fully reflected in investment prices.
That would probably also incentivise
further and deeper investment analysis
of sustainability risks and opportunities,
create incentives for change at enterpriselevel, and facilitate a greater focus onsustainability impact by investors.

48

As Parts A and B of this report make clear,
it is not always possible to answer thequestion of what legal rules on investment
require or permit just by looking at what
they ‘say’ (their ‘black letter’). Whatrules require or permit in practice mustalso be worked out by reference to thecircumstances in which they are applied(see Part B.2.2).

different from what they do today, or
they can influence how those legal rules
are understood.
• Secondly, they can change thecircumstances within which investors
seek to discharge their legal duties or
exercise their discretions but, clearly,
the circumstances only become relevant
if the primary duties and discretions
require or permit IFSI in the first place.11
49

The following covers both sorts ofintervention. Policy options in Section 2.2
principally concern the first. Policy optionsin Sections 2.3-2.5 focus on the second.
However, in the case of the second, it is
not feasible in an exercise of this sort tocover every circumstance that could have abearing on how investors follow legal rules.
In particular, this report does not consider
industrial and economic or fiscal policy,
although these are fundamental, among
other things, because of what they signal toinvestors and the investment opportunities
they may generate (see Box 2).

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

This has important implications forpolicymakers. It means that those seeking
to influence investor behaviour have two
broad ways of doing so.
• First, they can change the substanceof investors’ existing primary legal
duties and discretions, to say something

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Box 2 – The relevance of industrial, economic
and fiscal policy
An important area of policy is beyond the scope of
this report. Legislators could significantly change thecurrent context in which investors discharge theirduties through industrial, economic and fiscal policies.
Requiring a price to be paid for (or evenprogressively prohibiting) unsustainable businesspractices, or financially incentivising particularsustainability objectives, is a case in point. Carbon
pricing is an example of this type of approach:applying a price to carbon emissions to reflect
their wider cost to current and future generations
results in those costs being ‘internalised’ by theemitter and, consequently, passed on to those who
consume the emitter’s goods and services, and2.2

Addressing legal limits or uncertainties

50

This section covers options for clarifying
or changing legal rules to broaden thecircumstances in which investors are
required or permitted to engage in IFSI or
are likely to do so, including:• the core content of legal rules that

stipulate investors’ investment duties, or
which provide them with discretion to
engage in investment approaches within
the scope of IFSI (Section 2.2.1 below);

the emitter’s investors, so influencing investment
decisions. More of the cost is borne now, rather
than by future generations, and money raised(whether through carbon taxes or the sale ofcarbon credits) can be invested in addressing theunderlying issue. Another example would be thesubsidisation of solar energy installations. The
effectiveness of measures like these is likely todepend on a consistent approach being adopted
across the major economies, and we recognise thepolitical obstacles to this.
The investment industry can only ever be a part ofthe solution to sustainability challenges. Industrial,
economic and fiscal policy interventions arelikely to have a more direct impact on primaryeconomic activity and to influence the assessments

powers to invest in opportunities wellaligned with IFSI (Section 2.2.4 below); and• the use of concepts like ‘financial’ and‘non-financial’ in legal rules and official
guidance (Section 2.2.3 below);• legal or accounting rules that could

unnecessarily restrict use of investment

135

53

• legal rules that restrict, or could in the

future restrict, the extent to whichinvestors can undertake stewardship(Section 2.2.5 below).
2.2.1

Adjustments to core duties anddiscretions

51

As noted above, two key determinantsof what legal rules require or permit inpractice are the content of the rule, whatit ‘says’, and the circumstances in which aperson is applying it.

• increasing the likelihood of the rules

leading investors to engage in collective
action to achieve sustainability goals(Section 2.2.2 below);that third parties make in their dealings withbusiness enterprises, including investors. If, forexample, policymakers consider it important that
all enterprises have a clearly defined plan to reach‘net zero’ in their global operations by a given date,
it is fair to ask why they do not require it, rather
than relying on institutional investors to use theirinfluence to that end. Active intervention of thiskind by governments at a national level, reflecting
the international commitments they have given,
is also likely to generate investment opportunities
for those wishing to use their investment powers
to pursue sustainability impacts. The current
shortage of opportunities of this sort, as noted in
Section 1.6.2 above, is one of the impediments thatinvestors have highlighted to us.

52

What a rule ‘says’, again, involves broadly
two elements:• the ‘black letter’ of the rule as set out

in statute or in the form of judge-madelaw; and• what the rule is understood (rightly or

wrongly) to say.

54

In the case of the latter, there may also
be uncertainty over what a rule requires
or permits.
It follows that, if policymakers wished torequire or permit more extensive use ofinvestment approaches within the scope of
IFSI than at present, they should consider:• whether investors’ existing duties anddiscretions need to be revised; or

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES• whether existing duties and discretions

already require or permit the activities
that policymakers would like to see but
are currently understood as not doing so.
55

Which of these is relevant can be
expected to vary depending on whether
the policymaker wishes to facilitate
instrumental IFSI or ultimate ends IFSI.
In the case of instrumental IFSI, if any
intervention is needed, the emphasis is
likely to be on clarification and guidanceFreshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

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as to the content of existing rules focusedon financial return. Extending the use ofinvestment approaches within the scope ofultimate ends IFSI is more likely to involvea mixture of legal reform and guidance. The
following looks at each sort of IFSI in turn.
(a)Instrumental IFSI(i)

Changing the content of legal rules

56

As discussed in Part B.3, it is reasonably
clear in all of the jurisdictions coveredthat most Asset Owners and theirinvestment managers with medium andlong-term financial objectives, where IFSI
approaches could reasonably be expected
to assist with these, are likely to be undera duty to consider whether they should
pursue them and, if so, to act accordingly.
On that basis, there should be no needto change substantive legal duties inany of these jurisdictions to require or
permit instrumental IFSI. However, wehave identified two areas below where
the substance of legal rules may needchanging although, in both cases, it may
be that guidance on existing rules would
be sufficient.

57

136

Remove doubt about benefitting nonbeneficiaries. Duties owed to beneficiaries
have generally been understood to requirethat investment powers be exercisedin beneficiaries’ financial interests. In
some cases, this may have been treatedas preventing any decision if it also
benefits a third party even where that is
not the decision-maker’s purpose. Many
investment decisions necessarily benefit
third parties, for example, the investee
enterprise and its customers and, in thecase of stewardship, all other interested
shareholders. However, where duties areunderstood more narrowly, one option
would be to make it clear that investors’
activities may also confer benefits on nonbeneficiaries, including benefits derived
from achieving sustainability impact goals,
where the relevant investor is acting withthe purpose of generating the investment
return it is legally required to pursue.
58

(ii)

The case of mutual funds. There is aquestion in some jurisdictions whether
the investment horizon of mutual funds isfocused exclusively on current beneficiaries
or may require a longer-term approach,considering, as for commercial companies,
the interests of shareholders (ie fundinvestors), ‘present and future’. Where thisis the case, policymakers could consider
providing guidance on why a longer-term
approach may be necessary, for example,
because of the likelihood that somecurrent beneficiaries will probably have
longer-term time-horizons, the possibility
that financial risks posed by sustainability
factors could crystallise in the short-term
and the perversity of the idea that aslong as a particular investment objective
is technically achieved, the fund and its
investors are indifferent as to whether thefund achieves long-term value growth.
If necessary, it would also be possible toconsider introducing an obligation to
manage the fund in the interests of present
and future shareholders, making clear that
this involves pursuing long-term financial
value growth and, where appropriate,
protecting the fund from systemic risks.
Changing the way legal rules are

ACKNOWLEDGEMENTS

understood

59

60

61

Some investors may currently be unawareof the effect of existing duties. There seems
to be wide acceptance that investors shouldtake account of ‘financially material’ ESG
factors. There has been less of a focus on the
more specific question of whether investors’
duties or powers extend to actively pursuingsustainability impact goals with a view tomitigating the financial risks created bysustainability factors or generating longterm value growth.
However, interest in the outcomes ofinvestor activity has been growing,
especially in the context of the attention
paid by policymakers and market operators
to stewardship:12 since stewardshipinvolves seeking to influence investee
enterprise behaviour (increasingly
thought of in terms of long-term value
growth taking account of sustainability
factors), those engaging in it may often beundertaking a form of IFSI.
Nonetheless, policymakers could consider
providing guidance confirming that,in discharging their duties, pursuingsustainability impact goals is among theoptions that investors should consider.

(b)Ultimate ends IFSI(i)

Changing the content of legal rules

62

The circumstances in which legal rules
require or permit ultimate ends IFSI in
the jurisdictions covered are more limited
and less uniform. If policymakers wish toencourage ultimate ends IFSI, legal changes
will be required. In approaching this,policymakers face difficult and politically

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

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sensitive decisions of the sort described inBox 1 above. They may also need to consider
how to ensure that any new discretions are
not abused and how to provide reassurance
that institutional investors will not be
exposed if they pursue ultimate ends IFSI
and there is underperformance in spite of
their good faith management efforts (seeBox 3 below).
63

64

65

137

really be permitted if the minority are
effectively locked in (as will be the casewith many occupational pension schemes
but recognising that there is currently asimilar issue for beneficiaries who want
their sustainability priorities to be taken
into account) unless perhaps they are
not financially disadvantaged? A second
challenge is how to ascertain beneficiaries’
priorities, and what should happen if
these change over time? Should there bea requirement for institutional investors
to ascertain beneficiaries’ wishes in thisarea, and how often (but see Section
2.3.4 below)? It would be possible forpolicymakers to provide for processes thatinvestors should undertake to establish
beneficiaries’ views, or at least to provide
guidance on what is appropriate. Finally,
how much weight should sustainability
preferences receive if these could conflictwith the financial objectives of the relevant
investment arrangement, particularly
where the arrangement offers fixed orminimum guaranteed benefits?

Various options for legal reform are outlined
below. In each case, new rules would alsoneed to qualify any duty of an investor toact exclusively in the financial interests of
its beneficiaries, since ultimate ends IFSI
involves taking account of wider interests.
Permit or require beneficiaries’
sustainability impact preferences to betaken into account.13 This option could
be subject to financial return objectives
being prioritised. It is already possible inmost jurisdictions to establish investment
arrangements with explicit sustainability
objectives, in which individuals can choose
to invest. Further, in some jurisdictions,some asset owners may already havediscretion to take account of beneficiaries’
sustainability preferences in the way they
manage their assets.14 This concept could
be taken further.
Nonetheless, this sort of approach raises
some difficult issues, the first being thatinvestors may not be able to cater forbeneficiaries with differing sustainability
preferences within the same fund, soshould the rule perhaps be that funds
may be managed having regard to thesustainability priorities of a majority(by value) of beneficiaries? And can this66

Permit or require investors to takebeneficiaries’ assumed sustainability
impact objectives into account. Buildingon the previous option, a further option
would be to require or allow investors
to assume that their beneficiaries havea particular sustainability objective or
objectives, unless they indicate otherwise.
This ‘beneficiary presumption’ approach
could operate in a similar way to the policy
on organ donation in The Netherlands
and the UK which assumes willingness todonate at death, subject to an opt out.15
It could be particularly useful in the caseof existing investment arrangements
which are otherwise too narrow to permit
ultimate ends IFSI, but where changing
their terms is too cumbersome to be viablein practice. However, as with the previous
option, various questions would still need
to be resolved such as how to establish
which sustainability objectives should
be presumed (but see the discussion ofcentralised research at Section 2.3.4 below),
how to manage the interests of ‘dissenting’
beneficiaries, and how much weight thesustainability objectives should be given.
It might also be necessary to consider
possible issues of retrospectivity. Someof these questions may be less pressing
if the scope for ultimate ends IFSI were
to be subject to prioritising minimum
investment return objectives.
67

Permit or require ultimate ends IFSI
approaches if minimum investment
return objectives are met. As a variationof the previous option, investors could
be required or permitted to engage inultimate ends IFSI approaches more
broadly or by reference to specificsustainability goals, provided that certain
levels of financial return were being
generated. Policymakers would still needto decide which sustainability goals werepermissible and address a number of thequestions highlighted in relation to theprevious options.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

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68

69

70

138

Require ultimate ends IFSI in relation
to particular sustainability goals
regardless of impact on investment
return or subject to limits. In principle,
policymakers could conclude that there aresustainability goals that are so importantthat investors should be required to pursue
them or to refrain from activities thatare inconsistent with them regardlessof the financial consequences, or within
limits. Requirements of this sort arepotentially a blunt tool, so any use would
require particularly careful assessmentand may only be feasible, if at all, on alimited basis, for example, in relation
to some very precise and urgent targets.
However, one area that is being discussed
in some quarters is a requirement to alignportfolios with net zero. If widely adopted,
that could lead investors to engage in
IFSI since it seems unlikely that there
are currently sufficient net zero aligned
investments available for all investors toachieve that goal; further change is neededon the part of more carbon intensive
issuers and steps by investors to securethat would likely involve IFSI.16
Apply the above options to a certain
percentage of each fund. The options
described above could also be applied to aparticular percentage of investor funds, notthe whole portfolio.
Permitting directors to pursue investment
for the long-term success of thecorporate entity. Separately, directors ofcorporate entities are generally required
to exercise their powers in the interestsof the entity concerned. However, somejurisdictions would accept that investments
by a corporate entity established in thatjurisdiction that are not solely motivatedby narrow financial considerations can bein the interests of that entity, whereas the
position in others is less clear. So, a further
option, of particular relevance to insurancecompanies, is to amend directors’ duties
to make clear that these are not narrowly
restricted to generating financial returns,
but need to be understood by reference toa broader range of factors which may beconsistent with the company successfully
achieving its purpose over the long-term,
including potentially pursuing sustainability
impacts. Where the law already allows for
this, but is currently unclear, guidancemight be used as an alternative.
71

Terms of existing investment products
such as mutual funds and life policies.
Where existing rules are adjusted to allow
ultimate ends IFSI, policymakers mayneed to consider ways to facilitate theprocess of amending existing investment
product terms such as mutual funds andlife policies to reflect this, ie relaxing theneed for the relevant product providers togo through onerous and expensive investor
consent processes where these mightotherwise be required.

(ii)

Changing the way existing rules areunderstood72

In some cases, some investors may beuncertain of the extent of any discretions
currently available to them to pursue
ultimate ends IFSI. In view of that,policymakers may wish to provide clear
guidance on the circumstances in which

ACKNOWLEDGEMENTS

investors already have discretion to adopt
investment approaches within the scope ofultimate ends IFSI.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

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Box 3: Rules on ultimate ends IFSI: choice ofsustainability objectives and relationshipwith financial objectives
There is clearly a risk that increased freedom for
institutional investors to pursue ultimate ends IFSI
becomes a licence for them to pursue their ‘petprojects’ regardless of whether these would beconsidered a priority in the jurisdiction concerned.
Options for permitting ultimate ends IFSI thatinvolve having regard to the actual or assumed
views of beneficiaries might be an effective
constraint. However, in all cases, policymakers
may need to have some role in deciding whichsustainability objectives are most important andshould be in scope. Some of the options discussed
in Section 2.2.1(b)(i) are effectively different ways of
doing that.
This question may be approached differently
in each jurisdiction, but we anticipate thatinternational commitments given by the relevant
jurisdiction on achieving sustainability goals
would be one of the most important factors. Thisis particularly important in the case of risks suchas climate change, which can only be successfully
addressed by consistent efforts on a global basis.
Beyond this, policymakers will need to consider

73

139

Addressing many sustainability challenges
requires a multitude of actions from ahost of different actors. However, in somejurisdictions, some investors could havequestions about how far they are able toengage in collective action designed to help
in meeting these challenges if, consideredon an individualised basis, it is not possible
to measure precisely what difference

position individually, but also how theymight act collectively with others inways that can reasonably be expected tohelp in addressing sustainability-relatedrisks to their objectives;17

Ultimate ends IFSI investment approaches
could potentially involve a trade-off between
sustainability goals and financial objectives.
Whether or not that is the case, until theseapproaches become more widely establishedthere may not be a sufficient body of evidence
for the relative financial returns available fromthe different varieties of sustainability-focusedinvestment to convince liability-averse investors
to opt for them as part of their mainstream
capital allocation activities. If policymakers
wish to encourage ultimate ends IFSI they may
therefore need to consider rules that either: (a)permit some sacrifice of financial return, or theassumption of heightened investment risk, forthe sake of a positive sustainability impact; or (b)provide some form of legal ‘safe harbour’ should
returns undershoot a certain minimum in spite ofinvestors’ good faith management efforts.

• collective activities of this sort can

assist in discharging duties to pursue
a given investment objective, even if it
is not possible to precisely quantify thebenefit or what difference the investor
has made, and can in principle betreated as beneficial both collectively
and individually for those involved(without having to ‘pro rate’ the benefit
in some way) since, like political stability
and security, the benefit of sustainablesystems is enjoyed as a whole by each
person or entity that depends upon them;More important than the precise content of any
such rule will be how much certainty it offers
to investors that good faith efforts to pursue
positive sustainability impact will not expose
them to compensation claims from those who aredisappointed by the financial returns achieved.

• decisions on participation in a collective

action concerning a particularsustainability outcome can take accountof reasonably anticipated cooperative
action by other third parties which islikely to further progress towards thesame sustainability outcome;18 and• focus on the importance of the logicalthe investor’s involvement has made to
the outcome and the financial benefit ofparticipation for their portfolio.

2.2.2 Goals of collective action as a basis forindividual decisions to pursue impact
through cooperation
74

The essence of cooperation is that theresults can only be achieved collectively
and collective action among investors is
now widespread. However, policymakers
could consider issuing guidance or making
rule changes to provide reassurance.

75

Guidance: among other things, guidance
could, for example, make clear that:

ACKNOWLEDGEMENTS• investors should not just consider their

how best to balance interests of the sort discussed
in Box 1 above.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

and evidential credibility of theinvestor’s explanation of the difference
it is seeking through collective action as
relevant to the investor’s legal objectives,
more than the precise quantificationof the investor’s individual impact andportfolio outcome of involvement.
76

Legal rules: it would also be possible toput some of this in the form of a legal
presumption so that, essentially, wherea given sustainability factor reasonably

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foreseeably creates a risk to the longterm value of a particular investment
arrangement, there would be a prima
facie presumption: (a) that the relevant
asset owner should not just consider its
position individually, but also how it can
act collectively in ways that can reasonably
be expected to help in addressing the risk;and (b) that collective activities of this sort
can assist in discharging duties to pursue agiven investment objective even if it is notpossible to precisely quantify that benefit
or the difference the investor has made.
77

indirect financial implications are not
relevant (for example, reputational damage
caused by a firm’s negative sustainability
impact leading to loss of business
opportunities); or (b) that where the riskspresented by a sustainability factor are
hard to predict, that means it does nothave financial implications.
79

Disclosure: investors could be invited or
required to disclose which sustainability
factors they consider relevant to them inpursuing their investment goals and theirapproach to engaging in collective action
concerning those factors and, if they do notact collectively, their reasons (see Sections
2.3.5 and 2.5.1).

2.2.3 Financial factors and non-financial
factors78

140

Use of expressions such as ‘financial
factors’ and ‘non-financial factors’:
policymakers should consider reviewing
the use of expressions such as ‘financial
factors’ and ‘non-financial factors’ inconnection with investor duties andcorporate reporting. It can sometimes
give the misleading impression thatsustainability factors are somehow nonfinancial, which is clearly not the casefor at least some sustainability factors, as
growing activity in relation to the TCFD
recommendations and sustainability
reporting reflects. Policymakers should
also address any impression: (a) thatsustainability factors that only have

80

Instead of focusing on whether a particularfactor is ‘financial’ or ‘non-financial’
policymakers need to address the objectiveof the person taking the relevant factor
into account, and, at least in an investment
context, whether that objective is therealisation of financial goals or someother sort of goal. Where an institutional
investor is required to pursue exclusively
financial goals, whether a sustainability
factor is taken into account would turnon the potential financial implications forachieving the investor’s financial purpose(and where the investor is pursuingsustainability impact goals to do so, itwould be a form of instrumental IFSI).
Where the investor has discretion to
pursue broader goals, whether subject to,in parallel with, or even with priority overfinancial goals, then taking a sustainability
factor into account would be based on its
implications for those goals (and where
the investor is pursuing sustainability
impact goals to do so, it would be a form ofultimate ends IFSI).
Clarifying rules and guidance onsustainability factors: where existing
duties and associated guidance thatconcern achieving financial goals or
managing financial risks are revised tomake clear that sustainability factors

may, and in some cases will, need to beconsidered in order to discharge thoseduties, any changes need to be made in a
way that is clear: (a) that the amendment
is only clarificatory and that any factor
that is relevant to the discharge of thoseduties (whether sustainability-related orotherwise) needs to be taken into account;and (b) that while some sustainability
factors are likely to require consideration,
the range of sustainability factors is broad,so that not all of them necessarily will.
2.2.4 Regulatory rules that indirectly
restrict IFSI
81

82

Types of investments that asset owners
can hold: policymakers could consider
reviewing rules governing the assets thatinvestors are permitted to hold, including
liquidity and portfolio requirements, andassociated accounting standards to ensurethat they do not unnecessarily restrict
investment in enterprises likely to havepositive sustainability impacts. For example,
accounting rules, and, where relevant,prudential rules tend (for understandable
reasons) to value early-stage investments
cautiously and treat them as illiquid.
Some investments, such as infrastructure
investments, that could be required toaddress sustainability challenges such as
adaption to climate change will be subject
to these rules, so that this could prove to bea significant deterrent to instrumental andultimate ends IFSI in practice. Policymakers
could consider a different approach toinvestments they feel are the most urgent.19

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

Technical operational barriers: regulatory
regimes for asset owners could be reviewed
to assess whether they inadvertently

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impede IFSI investment approaches, forexample, if they require valuations or
performance assessments against theinvestment objectives of a product in waysthat assume these objectives are exclusively
financial and do not contemplate ultimate
ends IFSI.

addition to existing defences) of reducing
the risk of this sort of disruption tolegitimate transactional activity.
85

2.2.5 Rules that could inhibit stewardship
activities
83

84

141

Effective stewardship requires frequent
two-way communication by investors withenterprises, and a collective approach byas many investors in an enterprise as ispracticable. Policymakers could review
existing legal frameworks to ensure thatthey do not inadvertently inhibit legitimate
stewardship activities designed to achievesustainability impact goals.
Price sensitive information: it ispossible for two-way communication ofthis sort to steer clear of informationthat is unpublished and price sensitive.
However, the need to do so could
potentially constrain enterprise-investor
communications. Policymakers could
review the extent to which existing insider
dealing and market abuse rules are having
this effect and whether there is scope tofacilitate more in-depth conversations
regarding sustainability issues. For
example, where price sensitive informationis communicated to investment managers,
while there are potentially ways to handle
it so as to minimise disruption, receipt of
the information can make it difficult forthem to continue to transact in affected
securities for their clients. Policymakers
might consider whether there are ways (in86Concertedness/control: in somejurisdictions, shareholders acting
collectively can (if they account for morethan a certain percentage of shares)
incur obligations to make an offer forthe remaining shares or even trigger
regulatory consent requirements forcontrollers of a regulated entity. Most
stewardship activity in relation tosustainability (at least as it has been
conducted to date) is unlikely to trigger
these regimes. However, not least in viewof the growth of activities of this sort,policymakers could consider making
exceptions where the focus of the collective
action is to encourage a more sustainableapproach by the enterprise concerned, or
provide comfort that collective shareholder
stewardship activities are not caught.20
Competition law: collective stewardship
activity could potentially affect themarkets for certain goods and services.
If so, in principle this could fall foulof current antitrust laws in many
jurisdictions. Competition regulators
have been increasingly open to discussing
sustainability initiatives and are starting
to recognise the need for further andmore harmonised guidance. Various
consultations are ongoing that are
expected to clarify and, to some degree,
soften the past enforcement climate andprovide a better framework to accountfor wider society benefits.21 However,policymakers could consider introducing
an explicit safe harbour for sustainability-87

related collective activity by investors andother interested third parties.

ACKNOWLEDGEMENTS

Requisition of shareholder votes:
policymakers could assess whether
the terms on which shareholders canrequisition shareholder votes unnecessarily
restrict bona fide stewardship activity(for example, because of the number ofshareholders needed to requisition a vote,the aggregate amount of capital that theymust hold, or the consequences of losing
a vote).

EXECUTIVE SUMMARY

2.3

Steps to build the IFSI ‘infrastructure’88

Governments can facilitate economic
activity by ensuring that the necessary
infrastructure is in place, thereby
affecting what is commercially feasible.
Similarly, policymakers could support
the development of areas of knowledge
and practice that are relevant to IFSI,
increasing the likelihood of legal rules
leading investors to engage in IFSI.

2.3.1

Support for the development ofmarket-based IFSI infrastructure

89

Part A.2 noted various needs for investors
engaging in IFSI: the ability to define
the sustainability impact goals being
targeted and link them with overarchingsustainability outcomes; the ability toassess the changing impact of businesses
and third parties on sustainability factors;
the ability to reach a robust understandingof the investor’s contribution to any
outcomes; and a shared understanding,among other things, as to the longterm financial impact of particularsustainability risks and the effectiveness

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

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of IFSI investment approaches in achieving
sustainability goals, and in preserving
and generating investment value. Where
navigating these is too complex or costly,
this will limit what investors can do.
90

In all these cases, policymakers may beable to help build or foster the necessary
infrastructure.22 The multi-disciplinary
nature of some of the challenges makes
it likely that this would often need to
involve financing or otherwise facilitating
specialist work23 and fora in which
technical specialists, investors, enterprises
and regulators can research, brainstorm
and agree on effective strategies, much as
is happening in the context of the TCFD
and, more recently, the Task Force on
Nature-related Financial Disclosures.24
Governments and regulators also have a
crucial role in ensuring that information
about what works, and what does not,is widely promulgated and accepted asthe ‘authorised version’, for example: by
establishing centres of excellence which
can identify and help to generate areas of
emerging good practice and highlight how
they could be relevant in discharging legal
duties; using ‘soft’ regulatory signposting(through speeches and the like); andenshrining standards formally in legal
frameworks (much as is now happening
with the TCFD Recommendations).25

2.3.2 Frameworks for IFSI capabilitybuilding by investors
91

92

Policymakers could also consider steps
to support a rigorous approach among
investors to addressing the issues
highlighted above.
Processes, systems and controls foraddressing sustainability impact: one
approach might involve establishing aframework of practical steps that investors
could or should take:– the product’s sustainability goals andthe way progress will be assessed areclearly defined and communicatedand it is clear what contribution the
product is intended to make in realisingoverarching sustainability outcomes;

to potential risks to their financial goalspresented by sustainability factors, and• in operating investment products or

strategies specifically designed to achieve
positive sustainability outcomes.

94This would involve a form of ‘processregulation’. It could help to heighten
attention to and, over time, strengthen
the methodologies being applied, in turncontributing to infrastructure development
as more operators seriously address
themselves to the issues involved.
The legal status of standards of this sortmight range from good practice statements
in relation to existing rules (for example,
rules that require investors to pursue
beneficiaries’ best interests)26 throughto formal entity, service or productgovernance regimes.27• In terms of risks to investment goals (oropportunities) created by sustainability
factors, standards could cover, forexample, investors’ systems and controls
for identifying and determining how toaddress these.

142

appropriate for investment products
and strategies held out in ways thatsuggest they have specific sustainability
goals. Standards could focus on theprocesses and techniques used indesigning, creating, documenting,operating and distributing the relevant
products to ensure that rigorous andsound standards are applied in the areas
mentioned at Section 2.3.1 above so that:• generally, in considering and responding

93

ACKNOWLEDGEMENTS• More stringent standards may be– investors understand any potential

financial return impact of pursuingsustainability goals; and– investors receive adequate sustainability

performance information.
95

96

Disclosure: the effectiveness of regimes ofthe sort described above could potentiallybe strengthened by requiring public
disclosure of the steps investors are taking,see Section 2.5.1 below.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

Individual staff accountability: it would
be possible to supplement the above
with personal accountability regimes,
whereby particular members of staff have
responsibility under the regulatory regime
for the investor’s compliance.

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2.3.3

Provision of assessment and decisionuseful information on businessenterprises

97

Internationally consistent disclosure
regimes for business enterprises thatgenerate ‘decision-useful’ information are
a key foundation for all forms of IFSI andpolicymakers need to consider, as indeed
they already are, how best to facilitate
these and various associated matters, suchas how far disclosed information should beexternally validated.

98

Disclosure regimes generally: logically,
investors pursuing sustainability impact
goals could be expected to need two sorts
of information:

second category. The recommendationsof the TCFD are a highly influential
international example of a disclosure
framework which is especially focused on
the first sort of information, in relation toclimate change.29 At the level of national
disclosure regimes, many jurisdictions
have sustainability-related disclosure
requirements. However, they tend not tocover both of the categories of information
above30 and there is not yet enough focus
on the specific steps being taken bycompanies and the outcomes achieved ineither case.
100• how the enterprise is impacted

and is responding to the risks andopportunities presented by relevant
sustainability factors and associatedtransition processes, within what
timeframe (including steps plans) andwith what success; and• how the activities of an enterprise havean impact on sustainability factors,
whether the company aspires to havea more positive impact, what steps it istaking and within what timeframe, andhow its impact is changing.28
99

143

For investors considering how to protect
their portfolios from systemic risks, these
two sorts of information would seemto be connected: looking at economic
systems as a whole, one of the sources ofsustainability risks in the first category
is likely to be the activities of otherbusinesses, such as the sustainability
impacts of enterprises referred to in the

101

Policymaking on disclosures in the second
category may need to address a number ofpotentially challenging questions similar tosome of those highlighted in relation options
for rules facilitating ultimate ends IFSI (seeSection 2.2.1(b)(i)), such as what sustainability
factors need to be covered and for what
purpose. Those making disclosures may also
face ‘infrastructure’ challenges of the sortdiscussed at Section 2.3.1 above, for example,
in assessing impact. Consequently, there is
likely to be a common interest among thosein the investment community and investee
companies in developing effective assessmentand measurement methodologies.
Financial quantification of costs andopportunities: more specifically, as thecosts and financial opportunities presented
by sustainability factors become better
understood, or perhaps to accelerate
a common understanding of these,
policymakers could consider requiring
enterprises to estimate and publish these,such as the potential cost of certain
sustainability risks if left unmanaged.

Recommended TCFD disclosures on
corporate strategy already move in thisdirection in the case of climate change, forexample, in recommending disclosure ofclimate-related risks and opportunities forthe organisation’s business, strategy andfinancial planning.31
102

Sustainability transition/action plans:for sustainability risks that have been
widely identified as creating material
foreseeable systemic risks, such as
climate change, policymakers could also
consider requiring enterprises to develop
and publish their transition plans, withestimates of anticipated costs, possible
obstacles to transitioning in the envisaged
timescale, and any expected revenue
enhancement. Policymakers could also
consider whether these plans should be: (a)put to a shareholder vote; and (b) subject
to independent validation. It would also
be possible to consider a similar approachin relation to action plans developedby enterprises to address other areas ofsustainability impact.

2.3.4 Establishing greater clarity about
investor sustainability attitudes
generally: centralised coordination
103

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

Part A.4 commented on growing
evidence that individual investors wantsustainability factors to be taken into
account in how their investments aremanaged, and the possibility that asignificant number may expect that to
involve positive sustainability impacts.
Gaining a clearer view of investors’
sustainability attitudes generally may be
important for at least two reasons.32 First,

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it is relevant to some of the options forfacilitating ultimate ends IFSI discussed in
Section 2.2.1(b). Secondly, Part B.3 notedcases where beneficiaries’ sustainability
wishes are relevant to investors in deciding
whether to engage in ultimate ends IFSI.
104

Policymakers could therefore consider
facilitating high-quality work, drawing
on relevant expertise and disciplines, tounderstand individual investor attitudes
in their jurisdiction to inform decisions on
how far sustainability outcomes should bereflected in the investment process beyond
what is needed to achieve financial goals.
It would need to be kept up to date andcould seek to address some of the issues
with work on this topic to date (see thesupplement to Part A, Appendix 3). Central
coordination of this work, and making
it a matter of government responsibility,
should help to reduce costs and potential
uncertainty for institutional investors ifthey are expressly permitted to rely upon
the output.

2.3.5 Steps to strengthen stewardship as it
concerns sustainability impact
105

Stewardship activities are likely to be key
in IFSI in many jurisdictions.

106

Stewardship codes and similar goodpractice statements: in jurisdictions where
there is currently no code or other similar
repository of good stewardship practice,policymakers could consider introducing
or facilitating one.

144

107

They could also encourage those who are
custodians of the stewardship code in theirjurisdiction to consider:• its scope, to ensure that it is sufficiently

broad, in terms of the sorts of businessenterprises, investor-types andinvestment relationships covered (forexample, not just listed equity interests
but interests in debt instruments and in
private vehicles);• how the code addresses investors’

approaches to the sustainability positionof businesses covered including, among
other things:– risks, systemic or otherwise, createdby sustainability factors to which
the relevant enterprise may becontributing or exposed;33– avoiding a simplistic bifurcation

between financial and non-financial
factors (see Section 2.2.3 above) andrecognising the wider benefits ofattention to sustainability factors;34– the possible use of sustainability

impact goals by investors in working
with the enterprise in seeking toenhance long-term value growth andassessing progress towards them;35– the role of collective engagement withother investors and with other third
parties and policymakers as part ofthat process;36 and– a focus in reporting under the relevant

code on the results of investors’
stewardship activities (including
sustainability impact goals achieved),

ACKNOWLEDGEMENTS

not simply the processes they have inplace to engage in stewardship.37
108

Adherence to stewardship codes:
policymakers could also consider steps
to encourage adherence of investors to
stewardship codes:• Industry working groups on goodpractice and investor forums: they
could look at encouraging industry
participants or industry associations
to establish working groups to develop
guidance on good stewardship practiceunder the code.38 It would also be
possible to encourage the developmentof investor forums to facilitate collective
action, potentially jointly funded bymarket operators.39• Publication of stewardship policies,

expenditure and outcomes: where notalready required, policymakers could
consider disclosure by institutional
investors of their stewardship policies
and activities (see also Section 2.5.1
below),40 making clear what level ofresources is devoted to them, howactivities have been designed to serve
beneficiaries’ interests to the full,
how the investor seeks to achievesustainability impact goals and theoutcomes it has achieved.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES• External review of stewardshipstandards: policymakers could consider
whether there are ways of ensuring that
institutional investors’ stewardship code
activities are subject to independent
review and reporting, to encourage
compliance and so that examples of goodpractice can be shared.41

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109

110

Relationship between asset owners,
investment managers and consultantsin relation to stewardship: policymakers
could undertake work to assess whether
asset owner stewardship interests arebeing adequately reflected in the way
investment managers and consultants
provide their services or encourage
industry initiatives to do so (see also
Sections 2.4.2 and 2.4.3 below).42
Any shortcomings may best be addressedby industry work to establish good practicestandards. However, associated regulatory
regimes may also need attention since
they tend to focus on investment selection
more than stewardship. Possible rulechanges include: (a) a new requirement forinvestment managers to assess whether
their stewardship offering makes themsuitable for particular appointments; and(b) requiring periodic client reporting (withan explanation of stewardship outcomes,sustainability orientated resolutions the
manager has chosen not to support and why,
how activities have added value consistent
with the client’s sustainability impact goals
and the manager’s position on joining
investor coalitions, including reasons).

2.4

Addressing market features that may
result in sustainability factors being
underweighted in investment activity

111

The report has identified various areasin which current circumstances may
influence investors in ways that could
result in sustainability factors being
underweighted in the investment process.
The need for greater transparency about
the sustainability exposures of investee
enterprises was discussed in Section 2.3.3

145

above, which should help in valuations.
However, a number of other areas may
benefit from attention.
2.4.1

Portfolio theory and use of benchmarks

112

Assessment of the impact of portfolio
theory and commonly used benchmarks:
policymakers could consider facilitating
high-quality cross-disciplinary work
coordinated by a group of investors andinternational-profile academic institutions
on the use of key elements of current
portfolio theory and the use of benchmarks(see Part B.4) to establish whether they are
resulting in insufficient attention being
paid to sustainability factors, especiallysystemic risk, and whether this could
prejudice realisation of financial goals.43

113

114

on investment portfolios of systemic risks
from sustainability factors, possibly with apublic rating system indicating the qualityof the relevant training. Policymakers
could also consider a continuing education
requirement on sustainability risks forinvestor staff.
2.4.2 Basis on which investment managers
selected and appointed
115

Should a sufficient consensus emerge,
the next step might (depending, among
other things, on the investment industry’s
response) be for policymakers to encourage
market participants and other interested
parties to develop guidance on how best toaddress any shortcomings identified andto work on alternative or supplementarymodels. Given the technical and developing
nature of investment practice, we anticipate
that policymakers may need to encourage
the exercise of informed judgementon the part of market participants andavoid implicit or explicit prescription, forexample, of specific models in performancemeasurement, portfolio construction,
valuations or risk assessment.
Investment professional training:
policymakers could consider a review ofbusiness school and other training forinvestment professionals to ensure thatcurricula adequately address the impact

116

Assessment of the role of sustainability
factors in the selection of andrelationship with investment managers:
policymakers could facilitate a study ofasset owner due diligence on investment
managers, the terms on which they areappointed and the way relationships workin practice to assess whether longer-term
approaches (factoring in sustainability
impact risks and opportunities toclients beyond the term of managers’
appointment) are being properly reflected
and incentivised. If they are not, thestudy could consider what can be done tochange this. Asset owners may be reluctant(sometimes on legal grounds) to commit
to long-term appointments because thiswould restrict their ability to change
investment managers where they are notsatisfied with their performance. However,there may be scope for lengthening
appointment terms, subject to the ability
to terminate the relationship based on aformalised periodic review process (as issometimes the case where an insurer orinvestment manager sells a portion of its
business, but continues to manage theunderlying assets).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

Part of the solution may also be to
improve asset owners’ and beneficiaries’

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117

118

119

understanding of how sustainability-focusedinvesting can affect short term returns,
so as to reduce any discomfort they may
otherwise feel if short term performance isweaker than they might prefer.

121

Good practice standards: policymakers
may be able to encourage the developmentof good practice standards on investment
manager due diligence, appointment,
monitoring and relationship management
as this relates to sustainability factors,
by prompting industry initiatives.44 This
could also cover the role of investment
consultants and the standards they set forinvestment manager selection and review
processes (see Section 2.4.3 below).

2.4.4 Impact of trading activity
122

long-term corporate strategy that is more
likely to take account of sustainability
impacts or is more receptive to longterm investor stewardship? For example,
does it result in short term orientatedshareholder engagement, likely toundermine attempts to get companies
to take greater account of theirsustainability impact?

Disclosure: requiring disclosure byasset owners on how they seek to reflectsustainability factors in the appointmentof managers may also be an effective‘nudge’ to increase focus on this (seeSection 2.5.1 below).45
Stewardship: the relationship between
asset owners and investment managers
in relation to stewardship is discussed at
Section 2.3.5 above.

146

Policymakers could consider commissioning
studies on how far investment consultants
and fiduciary managers adequately
ascertain asset owners’ sustainability risks
and impact goals and reflect this in theservices they provide, and to assess whether
their advice and other services only placeappropriate reliance upon portfolio theories
and benchmarks of the sort discussed inPart A.4.

• does it tie up a significant portionof investible assets in a way thatmakes them ‘free floating’, ie so thatsustainability factors are never applied
to them? For example, does it mean that
there are no stewardship activities inrelation to a portion of company stock
and, if so, does it matter?
• what is the role of stock-lending

activities and how these might relate
to sustainability interests of thelending funds?
123

2.5

124

Policymakers could consider commissioning
work of a similar quality to that describedat Section 3.4.1 above, on the effect ofshort-term trading activity to establish
when it helps achieve, is inconsistent
with or is neutral with regard to positive
sustainability outcomes. For example:• does it counteract attempts to pursue

2.4.3 The role of investment consultants andfiduciary managers
120

Any concerns could be addressed by way of
guidance or new rules for asset owners on
their appointment and use of consultants
and fiduciary managers or through direct
regulation of the firms concerned.46

Policy measures, if any, would depend on
the outcome of the work.

This section groups a number of policy
options that could:• help to make more transparent

the extent to which investment
arrangements achieve sustainability
impact goals; and• help investors to pursue theirsustainability-orientated aspirations (seePart A.4).
125

ACKNOWLEDGEMENTS

Transparency and market discipline in
relation to IFSI investment approaches
through helping individual investors
realise their sustainability aspirations

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

There is evidence to suggest that public
interest in sustainability does influence
investment preferences when suitable
information is provided.47

INTRODUCTION
1.

2.5.1

Disclosure to beneficiaries on pursuitof sustainability impact goals byinstitutional investors

Potential impediments to IFSI
investment approaches

2.

Reform options

126

Policymakers could consider requiring
or encouraging institutional investor
disclosure of, broadly:

ANNEXESGLOSSARY• how their ability to meet any applicable

investment goals is impacted by relevant
sustainability factors and associatedtransition processes, how they are
responding, within what timeframe andwith what success;

REFERENCES• to what extent their response involves

pursuing sustainability impact goals,
including what goals, why (whether tomanage financial risks, realise financial
opportunities or as ends in their own
right), how and with what success; andFreshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCONTENTS

AREAS FOR LEGAL REFORMFOREWORDSINTRODUCTION• for asset owners, how this isreflected in the terms on which they
appoint investment managers and run
the relationship.
127

128

quality of the investor’s IFSI approach (seeSection 2.3.2).
130

The recommendations of the TCFD andassociated guidance address the firstof these in relation to climate change,
recommending, for example, that asset
owners describe: (a) how climate-relatedrisks and opportunities are factored
into relevant investment strategies;(b) engagement activity with investee
companies to encourage ‘better disclosure
and practices related to climate-relatedrisks’; and (c) metrics used to assessclimate-related risks and opportunities.48
It would be important for disclosures todistinguish clearly between:

131• investment approaches that are

essentially limited to selecting away
(through screening or otherwise) fromenterprises the financial value of whichis particularly negatively exposed tosustainability factors and/or towards
those that are not; and• approaches that are intended toachieve sustainability impact goals (ieIFSI approaches).
129

147

However, given the variety of approaches
that could fall within the scope of IFSI,
even those designed to contribute towards
addressing the same sustainability
impact goal (eg use of investment powers,
stewardship and policy engagement or only
some, and with varying levels of intensity
and using different techniques), it may
be important to identify ways of helping
investors understand the intensity and132

Disclosures to pension fund beneficiaries
could be made as part of the usual disclosureand reporting process for the relevant
fund. Where the disclosure concerns aninvestment product, disclosures could be
provided before any investment decision ismade and on an ongoing basis thereafter.
The aim would be to give investors theinformation they need to take decisions
in pursuing both their financial andsustainability goals (see Part A.4). However,
it would also assist those who advise themor make discretionary investment decisions
on their behalf to take adequate account ofthese matters in doing so.

133

Given the need for standardisation indisclosures to facilitate comparability(conceptually and in content andpresentation), disclosure regimes ofthis sort are likely to need someregulatory underpinning.
Examples of existing disclosure regimes
include China’s ‘green investment’ selfevaluation regime for securities investment
funds,49 the Regulation (EU) 2019/2088 on
sustainability-related disclosures in thefinancial services sector (SFDR)50 and theUK’s new climate change disclosure andgovernance regime for pension funds.51
However, they may not always prompt thosemaking disclosures to distinguish clearly
between taking sustainability factors into
account as a matter of investment selection
and intentionally targeting positive
sustainability impact goals.

ACKNOWLEDGEMENTS

2.5.2 Sustainability impact focusedinvestment products: encouraging
greater rigour and transparency

134

There is growing recognition among
policymakers internationally of the riskof ‘greenwashing’ or ‘ESG-washing’.52
Policymakers have a key role in ensuringthat the integrity of sustainability impact
focused investment approaches is notdamaged by misleading claims about the‘sustainability credentials’ of investment
products.53 However, responses hitherto havenot always specifically addressed the riskof ‘impact washing’. In terms of productsthat are designed to pursue an IFSI approachin managing the relevant assets the goalof policy intervention would therefore beto establish a clear distinction between,
essentially, three categories: investment
products generally; those that take someaccount of sustainability factors but do not
involve intentionally pursuing sustainability
impact goals; and those designed to pursue
sustainability impact goals.
Product labelling: there is a case for
introducing regulatory requirements thatmust be satisfied (much like those thatexist in some jurisdictions around useof the word ‘guaranteed’ to describe thepayout on an investment product) wherewords like ‘sustainable’, ‘responsible’,‘SDG compliant’ or ‘impact’ are used tomarket products such as mutual funds andinvestment-based life products.54 These
could include, for example, minimum
operating standards and the sort of
information that must be made available toinvestors prior to their investment, and on

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

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an ongoing basis thereafter. An approachof this kind might also be combined withthe sort of product governance regime
and a disclosure regime described above at
Sections 2.3.2 and 2.5.1 respectively.5556 It
would be important to be clear on whichlabels can be used to describe products thatinvolve the use of IFSI.
135

136

137

Mandatory disclosures: a further step
might focus on investment productsthat do not involve the manager of the
product intentionally seeking to achievesustainability impact goals. It would bepossible to require the ‘key facts’ saledocument for investment products ofthis sort to include a clear statement tothat effect.
Rating arrangements: policymakers mightalso seek to encourage the development of
rating arrangements to provide effective
rankings of products by reference to therigour of their approach to achieving
sustainability impact goals.57
Investor redress: where they do notalready exist, policymakers might also
consider simplified investor redress andcompensation regimes in relation to
product providers where sustainabilityrelated products are not operated in amanner consistent with the way they havebeen held out, particularly in relation to
pursuing sustainability impact goals.

2.5.3

Investment distribution: taking accountof investors’ sustainability aspirations

138

As discussed in Part A.4, while theinvestment distribution and advice processaddresses investors’ financial objectives,intermediaries have not generally sought148

to establish, and investors have notbeen routinely prompted to consider,their sustainability objectives for theirinvestments. It is therefore likely thatinvestors’ sustainability aspirations havenot been adequately reflected in thedecisions they have made.
139

140

Non-advised distribution: where an
investor is not appointing an investment
manager and is not seeking advice on what
product to select, policy intervention toaddress this issue may need to rely largely
upon disclosures and product labelling of
the sort discussed at Section 3.5.1 above.
Advised distribution/investment
management: where an investor isseeking advice or investment managementfrom a firm, policymakers could consider
the following.
• Suitability requirements: investment

managers, investment consultants,
investment advisers (and otherrelevant intermediaries on whose
advice or discretion investors rely)
could be required to establish a client’s
sustainability objectives at the outsetof their relationship, including theirviews on the pursuit of sustainability
impact goals and their investment
horizon, regularly update them
thereafter and reflect them in the way
they provide their services and in therecommendations they make.58

the investor wishes their money to be
managed so as to help to achieve certain
sustainability goals, and to reflect thesein advice given. As with the approaches
to amending key legal investment
management duties discussed at Section
2.2.1(b) above, various issues would need
resolution in relation to the second ofthese, including which sustainability
goals should be presumed. Research of
the sort described at Section 2.3.4 could
inform this.
141

Overarching duty regarding retailinvestor outcomes: in principle, it would
also be possible to consider introducing
overarching duties towards investors that
apply to all those involved in investment
product and service provisions to act so
as to achieve the outcomes that the end
investor is entitled to expect, including
sustainability outcomes.59

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES• Investor presumption: alternatively,

firms could be permitted to presume,unless an investor specifies otherwise:(a) that the investor has a long-term
investment horizon; and/or (b) that

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2.5.4 Individual investor education
142

Disclosure and suitability regimes of thesort described above depend on investors
understanding the significance of what
they are being told or asked, for example,
the difference between investment
screening (in isolation) and approaches
within the scope of IFSI. Facilitating
ultimate ends IFSI could also create risks if
investors do not grasp the possible tradeoff between pursuing sustainability impact
goals and their desired financial return (sothat there is an important policy threshold
between situations where ultimate ends
IFSI is permitted but financial return isprioritised, and those where it is not).60
Policymakers could therefore consider
undertaking or encouraging others toundertake investor education campaigns to
help investors understand, broadly: (a) that
their money can make a difference; (b) how
it can do that, especially the role of IFSI;
and (c) the possible trade-offs involved.61

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

149

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1Each jurisdiction has its own unique processes and institutions bywhich to effect changes of the sort discussed. We use the genericterm ‘policymakers’, recognising that this may mean legislatures,executive branches of government, regulators, or even courts,
depending on the context.

2

In these cases, the purpose of the legislation is often described in an
introductory section, or in recitals.

3

Dionysia Katelouzou and Eva Micheler, The Market for Stewardshipand the Role of Government, ECGI, Law Working Paper No
556/2020, December 2020.

4

For example, in Australia, the Treasury Laws Amendment (Your
Future, Your Super) Bill 2021 which is awaiting Royal Assent (before
coming law), imposes APRA-regulated trustees of superannuation
funds act in the ‘best financial interests’ of beneficiaries. This
may place greater focus on the financial considerations ofsuperannuation fund trustees and result in a reluctance to engage in
IFSI in circumstances when strong, short-term financial returns are
not guaranteed.

5

See, for example, Financial Stability Report, Bank of England,
August 2020, 39-43.

6

See Part A.1.4.

7See, for example, Treasury Laws Amendment (Your Future, Your
Super) Bill 2021 in Australia requiring superannuation trustees
act in the ‘best financial interests’ of beneficiaries. The need to act
in the best financial interest is not necessarily inconsistent withIFSI but trustees need to be mindful of not creating unintended
outcomes that impact sustainability as they attempt to derive strong
financial returns in the short and long term, creating a challenging
environment to be effective fiduciaries.

8

See, for example, Creating Impact: The Promise of Impact Investing,
IFC, 2019, 70; From the Margins to the Mainstream: Assessmentof the Impact Investment Sector and Opportunities to Engage
Mainstream Investors, a report by the World Economic Forum
Investors Industries, 2013, 24.

9For example, in the United States, BlackRock, 2019 Investment
Stewardship Annual Report 9 (2019), https://www.blackrock.com/
corporate/literature/publication/blk-annual-stewardship-report-2019.
pdf.

10

For example, in Australia, McVeigh v Retail Employees
Superannuation Pty Ltd [2019] FCA 14, where a fund member
commenced litigation for the trustee’s failure to adequately handle
climate change risk. The settlement reflects the initiative trustees
should take, discharging their duties whilst actively considering
climate change risk.

11

There is a considerable range of ways to do this. Some involve using
other legal rules. Possible approaches range along a spectrum
from, very broadly, ‘hard-edged’ prohibitions on particular sorts ofactivity, to duties governing the way certain activities are carriedon, to ‘process regulation’ stipulating steps that need to be taken
or matters taken into account in carrying on an activity, to rules
requiring certain disclosures about how an activity has been carriedon which may ‘nudge’ the person to whom the rules apply toconsider more carefully how they conduct that activity. However,policymakers do not need to resort to legal rules. For example, they
could stimulate the development of ‘soft law’ standards, such asindustry codes and guidance that are typically not legally binding
but may have a bearing on how legal rules are applied, (since,among other things, accepted market practice may be referenced

150

by courts or regulators in assessing what to expect of a ‘prudent’or ‘reasonable’ person in the relevant investor’s position (see Part
B.4, Box 5)). Or they could provide a catalyst for groups or fora to beestablished within which industry practice and collective activities
can develop, or commission strategic research or investigations.
More fundamentally, they could also take steps that change theinvestment landscape, for example, through the way they regulate
investee enterprises.
12

For example, as noted in Part B.3, through the adoption of
stewardship codes.

13This sort of approach might create a potential conceptual problem
for some investment arrangements since it might conflict withthe overriding duty of the investment decision-maker to make its
own decision about what is in the best interests of beneficiaries.
However, viewed differently the decision-maker may be better
placed to discharge its duty if it properly understands beneficiaries’
preferences.

14

15

Rules for EU insurers, due to take effect in 2022, appear go astep further in requiring insurers to take account of customers’sustainability preferences established in the course of their productapproval process. See Amendment Solvency II Delegated Regulation
which amends existing provisions made under Solvency II to require
that, ‘where relevant … decisions of an insurance undertaking shallreflect the sustainability preferences of its customers taken into
account in the product approval process referred to in Article 4of Amendment IDD Delegated Regulation. While this provision
principally concerns the prudent person principle under Solvency II
and cross-refers to the product governance regime for insurers (seeSections 2.3.2 and 2.5.1 below), it nonetheless appears to involvea requirement to take investors’ sustainability objectives identified
in the course of product design into account when investing inaccordance with the prudent person principle.
See https://www.organdonation.nhs.uk/uk-laws/, accessed 26 May
2021.

16

See Mark Carney, Building a Private Finance System for Net Zero,
Priorities for Private Finance for COP26, 12.

17

For example, while it is not guidance on legal duties and only covers
stewardship, Principle 10 of the UK Stewardship Code provides
that signatories will ‘where necessary, participate in collaborative
engagement to influence issuers.’ Similarly, the Japanese
Stewardship Code provides that it can be useful if an institutional
investor, where necessary, engages with an investee company incollaboration with other institutional investors. Likewise, Guidance
Principle 4 of the Dutch Stewardship Code encourages groups ofinvestors to discuss issues of common interest which they could
pursue collectively towards one or several issuers.

18

Tom R. Tyler, Why People Cooperate: The Role of Social Motivations(Princeton University Press 2011).

19

Similarly, in most jurisdictions mutual funds that are registeredfor public distribution are subject to a number of portfolio
concentration and other investment limits. There are importantreasons for these. They could nonetheless, however, be assessed toensure that they do not unnecessarily restrict investment.

20

For example, the Australian Securities and Investments Commission
published its Regulatory Guide 128: Collective Action by Investors
in June 2015. It notes that takeover laws can present obstacles forinvestors as collective action can create a need to file substantial
holding notices or breach takeover provisions. However, it statesthat ASIC ‘recognise that investors should be allowed to cooperateand coordinate their actions concerning an entity in which they
have invested, in the interests of promoting long-term value for all
investors. At times, this type of engagement can be more effective
and efficient than individual investor engagement.’ The guidance
therefore aims to promote certain investor engagement by clarifying
the application of takeover laws to collective action by investors bygiving details of the likely legal effect of different types of collective
action and indicative examples of collective actions which areunlikely to result in concerns under takeover laws, and those which
are more likely to do so. Guidance of this sort has also been given
elsewhere, including Japan and the UK.
21

The most progressive (draft) guidelines to date addressing
the interplay of competition law and collaborations forsustainability are by the Dutch competition regulator: https://www.acm.nl/sites/default/files/documents/2020-07/sustainabilityagreements%5B1%5D.pdf. The EU Commission is currently looking
into the same issues as part of the review of the two Horizontal
Block Exemption Regulations and the Horizontal Co-operation
Guidelines. Further guidance by other major authorities, suchas the US Department of Justice or the UK’s Competition andMarkets Authority, would contribute significantly to the debate.
The latter notes in its annual report for 2020: ‘We will develop ourunderstanding of how climate change affects markets and consider
how … we can act in a way that supports the transition to a low
carbon economy.’

22

See, for example, the discussion of these issues in relation to climatechange in Mark Carney, Building a Private Finance System for Net
Zero.

23

Such as the UK’s ‘Dasgupta Review’: Partha Dasgupta, The
Economics of Biodiversity: The Dasgupta Review (HM Treasury2021).

24https://tnfd.info.

25

There are many examples of policy activity of this sort. The EU
sustainable finance taxonomy is an example of public-private
working with multiple technical specialists within a legal framework.
It establishes infrastructure (specifically, that can be used in
identifying activities that can be regarded as ‘sustainable’) that
could potentially be used, for example, in goal setting or assessment.
Likewise, South Africa’s National Treasury, as part of the South
African Sustainable Finance Initiative, has recently published a draft
sustainable finance taxonomy (https://sustainablefinanceinitiative.org.
za/wp-content/uploads/2021/06/Draft-Green-Finance-Taxonomy.pdf(accessed 4 July 2021) and the UK is also working on a sustainablefinance taxonomy, which is intended to align with the EU taxonomy(https://www.gov.uk/government/news/chancellor-sets-out-ambitionfor-future-of-uk-financial-services (accessed 4 June 2021)). Other
examples include the UK’s Centre for Greening Finance andInvestment, funded by the UK Government in recognition that there
is not enough credible detailed information on climate financial risk
to support accurate and cost-effective risk-modelling (see https://www.gov.uk/government/news/leeds-and-london-set-to-becomeglobal-centres-of-green-finance (accessed 4 June 2021)) and theUK’s Climate Financial Risk Forum, co-chaired by the UK Financial
Conduct Authority and Prudential Regulation Authority, which seeks
to build capacity and share best practice across financial regulatorsand industry and to advance the finance sector’s response to thefinancial risks from climate change (see https://www.fca.org.uk/
transparency/climate-financial-risk-forum). At an international level,in December 2020 the UN-convened Sustainable Insurance ForumACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

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announced that insurance supervisor members are to undertakea scoping study on the financial risks of biodiversity loss (seehttps://www.sustainableinsuranceforum.org/biodiversity-loss-andassociated-risks-to-be-addressed-in-new-study-by-un-convenedsustainable-insurance-forum/ (accessed 9 June 2021)).
26

27

For example, in Australia, in relation to MySuper products (thepension funds in which certain beneficiaries are placed by default if
they do not select another fund to join) superannuation trustees are
required to produce an investment strategy which includes 10-year
investment return targets and must publish 10-year investment
returns. In 2019, the Australian prudential regulator, the APRA,
produced a Heatmap Paper indicating how they would assess theperformance of MySuper products, which included assessment ofinvestment performance over three and five-year timeframes (andeventually seven and ten-year timeframes) and also the ability of
the fund to ‘continue to deliver quality member outcomes into the
future.’ An APRA Climate Paper, also from 2019, expressly recognisedthat ‘it is imprudent for entities or regulators to ignore [climatechange] risks’ and encouraged ‘regulated entities to consider climate
risks within their risk management frameworks, consistent with
APRA’s risk management prudential standards.’
In relation to EU entity governance, for example, MiFID II and MiFIDII Delegated Regulation (especially Article 21) contain requirements
for firms regulated under the Directive to maintain adequate
systems and controls designed to secure the proper dischargeof their responsibilities. The rules have recently been revised sothat they explicitly now require firms to take sustainability risks
into account (see MiFID II Sustainability Delegated Regulation). In
relation to EU insurance undertakings, see Amendment Solvency
II Delegated Regulation which amends existing provisions madeunder Solvency II Delegated Regulation to require that insurers takeaccount of sustainability factors in their risk management processes(see Article 1, Amendment Solvency II Delegated Regulation).
In relation to product governance, see for example Articles 16(3) and24(2) of MiFID II and Article 9 of MiFID II Delegated Directive. This
has recently been amended to require firms producing investment
products to consider sustainability factors in their product approval
process and take them into account in product governance andoversight arrangements for any financial instrument intended for
distribution to those wanting to invest in a financial instrument witha sustainability-related profile (see MiFID II Sustainability DelegatedDirective). In relation to EU investment-related insurance products,
see a recent amendment to regulations under the IDD which has asimilar effect (Amendment IDD Delegated Regulation). In relation
to UCITS, see a recent amendment to legislation made under the
UCITS Directive which requires management companies to operate
systems and controls for identifying and managing sustainability
risks (UCITS ESG Delegated Directive).

28

151

There could be reticence among some companies about thesecond, among other things, for legal liability reasons, so any policy
move in that direction might need to provide reassurance to them,much as is currently being considered in the case of proposals
to revise the UK listing regime to allow for greater disclosure of
forward-looking financial and other trading information (UK Listing
Review, March 2021, 38 et seq). An example of a regime that
attempts to address both sorts of information is the EU’s regime
on corporate sustainability reporting, under the Directive 2014/95/
EU of the European Parliament and of the Council of 22 October
2014 amending Directive 2013/34/EU as regards disclosure of nonfinancial and diversity information by certain large undertakings andgroups, OJ L 330, 15.11.2014, 1–9. This introduced a requirement(sometimes described as a ‘double materiality’ requirement) forcompanies to report both on how sustainability factors affect theirperformance, position and development (the ‘outside-in’ perspective)
and on their own sustainability impact (the ‘inside-out’ perspective).
The EU Commission has recently published a proposal for a directive
to amend this regime, having concluded that the existing framework
and associated guidance has not resulted in information of therequisite quality being disclosed (see proposal for a Corporate
Sustainability Reporting Directive (CSRD)).
29

30

Recommendations of the Task Force on Climate-related Financial
Disclosures, Final Report, Task Force on Climate-related Financial
Disclosures, 2017. While it is a disclosure framework, to make therecommended disclosures, disclosing organisations would need toconsider, among other things, how they address climate risks, forexample, in their governance and systems and controls. The extent
to which it might apply as a legal matter to any given enterprise will
depend largely on local law.
Other than the EU’s Non-financial Reporting Directive, anotherexception is China. The Chinese environmental authority has issued
the Measures for the Disclosure of Environmental Information byEnterprises and Public Institutions in 2014, under which companies
causing heavy pollution are required to disclose their environmental
information, including information relating to pollution discharge,
and the establishment and maintenance of environmental
protection facilities. Companies listed on the Shanghai Stock
Exchange STAR Market are also required by listing rules to disclose
information regarding social responsibility performance in theirannual reports and prepare the social responsibility report,sustainable development report, and environmental responsibility
report as appropriate.

31

Recommendations of the Task Force on Climate-related Financial
Disclosures, 20; Implementing the Recommendations of the Task
Force on Climate-related Financial Disclosures, Task Force on
Climate-related Financial Disclosures, June 2017, 15.

32

The need to establish and act on the sustainability preferences ofinvestors as individuals is discussed at Section 2.5.3 below.

33

For example, Guidance Principle 2 of the Dutch Stewardship Codestates that ‘in assessing the Dutch listed investee companies’ longterm value creation opportunities, risks, strategy and performance, it
is critical to consider environmental (including climate change risks
and opportunities), social and governance information (including
board composition and diversity) besides financial information.’
Principle 1 of the revised draft Code for Responsible Investing inSouth Africa contemplates that ‘investment arrangements andactivities reflect a systematic approach to integration of sustainablefinance practices, including the identification and considerationof materially relevant ESG and broader sustainable development
considerations.’ Likewise, Principle 4 of the UK Stewardship Codeprovides that signatories ‘identify and respond to market-wide andsystemic risks to promote a well-functioning financial system.’

34

For example: the Code for Responsible Investing in South Africa
states in describing its purpose that ‘[i]t is no longer appropriate
for institutional investors to focus on only monetary benefit to theultimate beneficiaries of investments to the exclusion of factorsthat impact on long-term sustainability.’ (Institute of Directors
Southern Africa, CRISA Code for Responsible Investing, 7); Principle
1 of the UK’s Stewardship Code provides that ‘Signatories’ purpose,
investment beliefs, strategy and culture enable stewardship thatcreates long-term value for clients and beneficiaries, leading to

ACKNOWLEDGEMENTS

sustainable benefits for the economy, the environment and society.’
35

36

37

In Brazil, for example, the Association of Capital Market Investors(Associação dos Investidores do Mercado de Capitais—AMEC) has
compiled a voluntary Stewardship Code for asset owners andinvestment managers. Those who adhere to AMEC Stewardship
Code have a duty to observe its Principle No. 3, which recommends
that institutional investors integrate environmental, social andgovernance factors in their investment processes and stewardship
activities, evaluating both their impact on risks and returns andtheir contribution to the sustainable development of the issuersof securities. The assets under management of all pension fundadherents to the AMEC Stewardship Code combined correspondto more than forty-four percent (44 per cent) of all AuM of Brazilian
pensions funds.
For example, as noted above, Principle 10 of the UK Stewardship
Code provides that signatories will ‘where necessary, participate incollaborative engagement to influence issuers.’ Similarly, Principle
3 of the revised draft Code for Responsible Investing in South Africa(CRISA) contemplates that ‘a collaborative approach is taken whereappropriate to promote acceptance and implementation of theprinciples of CRISA and other relevant codes and standards, tosupport the building of capacity throughout the investment industry
and enhance sound governance practice’ and makes a number ofpractice recommendations in support of this principle.
See, for example, the UK Stewardship Code, ‘How To Report’, 5et seq. Principle 6 of the Japanese Stewardship Code requires
an institutional investor to periodically report to its clients andbeneficiaries how it has satisfied its stewardship responsibility
including the exercise of voting rights.

38

The UK Asset Management Taskforce (Government, senior
representatives from the asset management industry, regulatorsand other key stakeholders) is an example of this, see Investing with
Purpose: Placing Stewardship at the Heart of Sustainable Growth,
November 2020.

39

See, for example, Eumedion (https://en.eumedion.nl/) and the UK
Investor Forum: https://www.investorforum.org.uk

40

For example, Article 3(g) of the SRD requires institutional
investors and investment managers to develop and disclose
their engagement policy describing how they monitor investee
enterprises (including, among other things, on strategy, financial
and non-financial performance and risk, capital structure, socialand environmental impact and how they cooperate with othershareholders and communicate with stakeholders in the relevant
enterprises). They must also provide annual disclosure of their voting
activity.

41

See, for example, UK Stewardship Code: Review of Early Reporting,
Financial Reporting Council, September 2020.

42

For example, in the UK the Asset Management Taskforce recently
published Investing with Purpose: Placing Stewardship at theHeart of Sustainable Growth. Recommendations include: (a)support for the commitment by UK trade bodies for investment
managers and pension funds to establish a new steering group
to explore how to embed a focus on long-term factors (including
stewardship) in the relationships between asset owners andinvestment managers; and (b) investment consultants should
provide more active support to clients in raising the standard of theirstewardship activities and alignment of the stewardship approachof investment managers to client stewardship needs, including
client oversight of managers, client engagement with managers on

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

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AREAS FOR LEGAL REFORMFOREWORDSINTRODUCTION
stewardship performance, and client engagement with beneficiaries
regarding stewardship priorities.

Investing Risk Alert, Division of Examinations of the US Securities
Exchange Commission, 9 April 2021, EU SFDR/Disclosure Regulation,
Building trust in sustainable investments, a speech by Richard
Monks, Director of Strategy, UK Financial Conduct Authority,
21 October 2020, and Recommendations on SustainabilityRelated Practices, Policies, Procedures and Disclosure in AssetManagement, Consultation Report, CR 01/21, OECD, June 2021.

43This builds on a recommendation made in The Kay Review of UK
Equity Markets and Long-Term Decision Making, Final Report,
July 2012 that the UK government and relevant regulators shouldcommission an independent review of metrics and models
employed in the investment chain to highlight their uses andlimitations.

53

44

In relation to climate change see, for example, UK guidance in
Aligning your Pension Scheme with the TCFD Recommendations,
The Pensions Climate Risk Industry Group, January 2021, Part II –Trustee governance, strategy and risk management: how to integrate
and disclose climate related risks, 13-14 and 37-40.

For investor behavioural risks that could result in ‘greenwashing’ or‘impact washing’ see, for example, Florian Heeb, et al., Do Investors
Care About Impact?; Impact Washing Gets a Free Ride: An
Analysis of the Draft EU Ecolabel Criteria for Financial Products, 2°
Investing Initiative, June 2019.

54

45

For example, Article 3(h)(2) of the SRD requires certain institutional
investors, where they appoint investment managers (including byinvestment in a mutual fund) to disclose on their website, on a‘comply or explain basis’, certain matters with regard to how they
achieve an alignment between the interests and perspective of
the investment manager and their own in relation to long-term
performance.

An example of this approach is China’s Catalogue of Projects
Supported by Green Bonds issued by the relevant Chinese financial
regulators, which specifies projects for which ‘green bonds’ (ie bonds
issued to finance projects related to environmental sustainability)
can be issued, such as the manufacture of more eco-friendly
equipment. Issuance of ‘green bonds’ will enjoy certain preferential
policy treatments.

55

One regime that uses labelling in this way to underpin the credibilityof investment products with explicit sustainability objectives is theRegulation (EU) No 346/2013 of the European Parliament and of
the Council of 17 April 2013 on European social entrepreneurshipfunds, OJ L 115, 25.4.2013, 18–38 or ‘EuSEFs’. EuSEFs engage ina relatively focused form of ultimate ends IFSI, involving financeprovision to non-publicly traded undertakings that have the goalof achieving measurable, positive social impacts as their primaryobjective’ (Art. 3(d)). Among other things, as a condition of carrying
the EuSEF label, the relevant fund managers must comply withvarious operating standards, including conducting their activities
so as to promote the positive social impact of the undertakingsin which they invest, applying high levels of diligence in selection
and monitoring, maintaining clear and transparent measurement
procedures to assess the impact of investee undertakings andrequirements to disclose the social goals and outcomes of the fundto investors. Articles 8 and 9 SFDR/Disclosure Regulation seek to dosomething similar in relation to, respectively, products that ‘promote
environmental or social characteristics’ and which have ‘sustainable
investment’ as their objective. Similarly, the French regulator, theAMF, released in 2020 a set of rules and guidance seeking to ensurethat fund managers may only communicate the ESG-related
features of their funds if they actually implement consistentinvestment approaches (see https://www.amf-france.org/en/newspublications/news/sustainable-finance-and-collective-investmentmanagement-amf-publishes-update-its-investor).

46

47

In relation to climate change see, for example, Aligning yourPension Scheme with the TCFD Recommendations, The Pensions
Climate Risk Industry Group, January 2021, Part II – Trustee
governance, strategy and risk management: how to integrate anddisclose climate related risks, 14-21 and Guide for assessing theclimate competency of Investment Consultants, the UK Investment
Consultants Sustainability Working Group, January 2021.
Walking the Talk: Understanding Consumer Demand for
Sustainable Investing, Cambridge Institute for Sustainability
Leadership, 2019, 19. See also Florian Heeb, Julian Kölbel, Falko
Praetold and Stefan Zeisberger, Do Investors Care About Impact?
25 February 2021 (available at https://ssrn.com/abstract=3765659),
which considers the effect of labelling that highlights impact.

48

Implementing the Recommendations of the Task Force on
Climate-related Financial Disclosures, 35-36.

49

The Asset Management Association of China (AMAC), the selfregulatory body of China’s securities investment fund industry, issued
the Green Investment Guidelines in November 2018. Under theGreen Investment Guidelines, a fund is required to conduct annual
self-evaluation on its status of ‘green investment’ (ie the investment
is related to environmental sustainability) and file the self-evaluation
report with the AMAC. The self-evaluation report includes filling aform that answers a detailed list of assessment questions related
to the fund’s ‘green investment’ status, including its internalmanagement mechanisms related to environmental sustainability
and the operation of ‘green investment’ products. The AMAC, basedon these self-evaluation reports, publishes annually the statistics andanalysis regarding the overall development of China’s environmental
sustainability investment in the securities investment fund industry.

50

SFDR or Disclosure Regulation.

51

While not yet in force, the Occupational Pension Schemes(Climate Change Governance and Reporting) Regulations 2021 are
expected to come into force on 1 October 2021, introducing new
requirements on reporting consistent with TCFD recommendations.
Their aim is to improve the quality of climate risk governance andthe level of trustee action in identifying, assessing and managing
climate risk.

52

For example, see The Division of Examinations’ Review of ESG

152

56

On 1 December 2020, the Securities and Exchange Commission ofBrazil (Comissão de Valores Mobiliários—CVM) published a Request
for Comments no. 08/2020, in which it proposes a new regulatory
framework for mutual funds. The CVM proposes to limit use of theexpression ‘sustainable’ (sustentável) in receivables funds’ names
to funds that have more than half of their portfolio comprised ofcredit rights the issuance of which was accompanied by a positiveenvironmental or social impact, as assessed by internationallyrecognised methodologies or by a third party opinion. Some of the
discussions held with market participants in the context of this RFC
concerned widening the list of restricted words and expressions andthe types of investment funds to which these naming restrictions
would apply, as an effort to combat ESG-washing.

57

For the sort of impact that ratings can have, see Marco Ceccarelli,Stefano Ramelli and Alexander F. Wagner, Low-carbon Mutual

58

59

60

61

Funds, ECGI Finance Working Paper No 659/2020, February 2021
looking at how the introduction of Morningstar’s ‘Low Carbon
Designation’ affected fund flows.

ACKNOWLEDGEMENTS

For example, MiFID II and MiFID II Sustainability DelegatedRegulation (especially Article 54) contain requirements for firms
providing investment advice and/or investment management toestablish the investment objectives of their clients and to reflect
these in the recommendations they provide and decisions they takeon behalf of the client. These rules have recently been revised torequire the relevant firms to make an assessment of sustainability
preferences of clients and take them into account in selecting
financial products, although they do not explicitly address positive
sustainability impact goals. Firms will also be required to prepare
reports for clients explaining how the recommendation meets aclient’s investment objectives, including sustainability preferences. In
relation to EU investment-related insurance products, see a recent
amendment to regulations under the IDD which has a similar effect(Amendment IDD Delegated Regulation).

EXECUTIVE SUMMARYThe UK Financial Conduct Authority is currently consulting onwhether to introduce a ‘consumer duty’ which would apply toregulated firms requiring them: (a) to ask themselves what outcomesconsumers should be able to expect from their products andservices; (b) to act to enable rather than hinder these outcomes, and(c) to assess the effectiveness of their actions (see A New Consumer
Duty, Consultation Paper CP 21/13***, Financial Conduct Authority,2021).
Adrian C. T. Borgers and Rachel A. J. Pownall, Attitudes Towards
Socially and Environmentally Responsible Investment, Journalof Behavioral and Exerimental Finance, 2014, Vol. 1, 27-44, 30.
See also Walking the Talk: Understanding Consumer Demandfor Sustainable Investing, Cambridge Institute for Sustainability
Leadership, 2019, 17.
For example, the US SEC has issued guidance on ESG and impact
investing for retail investors: see https://www.sec.gov/oiea/investoralerts-and-bulletins/environmental-social-and-governance-esgfunds-investor-bulletin (accessed 8 June 2021). Careful thought
would be needed on how best to reach potential investors inways that are intelligible and engaging. Examples of independent
initiatives include the ‘My Fair Money’ website in Germany (https://www.meinfairmoegen.de/infomaterial) and the ‘Finance ClimAct’project in France (https://finance-climact.eu). In the UK, see Make My
Money Matter (https://makemymoneymatter.co.uk).

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
INTRODUCTION
1.

Potential impediments to IFSI
investment approaches

2.

Reform options

ANNEXESGLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPCONTENTS

A LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJURISDICTION REPORTS

FOREWORDSINTRODUCTION

CanadaUnited Kingdom France

Netherlands

EU

Japan

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY

United States

153

BrazilSouth Africa

China

Australia

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AUSTRALIACONTENTSFOREWORDSINTRODUCTION

1.

INTRODUCTION

1.1

This Annex considers the laws of Australia
as at 31 January 2021. Sections 2 to 4
address the ability of Asset Owners to
Invest for Sustainability Impact where
the relevant portfolio does not have an
express Sustainability Impact objective.

1.2

1.3

As discussed in the main body of the report,
the expression ‘Investing for Sustainability
Impact’ is not a term of art. Rather, theexpression is used here as a ‘conceptualnet’ to denote any power or freedomon the part of an Asset Owner or its
Investment Manager to pursue one or more
Sustainability Impact objectives (instead of,or in addition to, financial return).

ACKNOWLEDGEMENTS

not necessarily preclude IFSI (whether
instrumental or ultimate ends IFSI).
1.4.2

1.4.3

The types of Asset Owners considered inthis Annex are:• superannuation funds;• registered managed investment schemes

and listed investment companies; and• life insurance companies and generalinsurance companies.
1.4

In this Annex certain underlying key
themes recur:

Best interests
Superannuation funds and registered managed
investment schemes
1.4.1

154

Standards applying to superannuation
funds and registered managed investment
schemes are often expressed referring
to duty to act in the ‘best interests’ of thebeneficiary. As discussed throughout
this report, though the best interest of
beneficiaries is defined with reference
to their financial interest, this may

1.4.4

The curial and academic considerationof the duty to act in the best interestsof beneficiaries as it applies to trustees
generally, and to APRA-regulated trustees
and responsible entities specifically arebroadly analogous.
When interpreting the duty to act in thebest interests of beneficiaries, Australian
courts have cited the English case of
Cowan v Scargill1 in holding that where
the purpose of the trust is to provide
financial benefits for the members,
the best interests of the members areusually the best financial interests ofthe members. More recently, the High
Court of Australia has held that: ‘[the]key factors in ascertaining the bestinterests of the members are the purpose
and terms of the scheme.’2 In the recent
decision of Australian Prudential Regulation
Authority (APRA) v Kelaher3 (Kelaher),Jagot J accepted the submission from therespondents (citing Thomas)4 that ‘acting
in the best interests of the beneficiaries is ineffect synonymous with a trustee’s obligation topromote and act consistently with the purpose
for which the trust was established.’5
In Kelaher, the view that the best interestsof members of a superannuation fund
for the purposes of this duty will be thebest financial interests of members was
submitted by APRA and accepted by Jagot
J.6 The best interests duty as it applies
to APRA-regulated trustees is overlaid
by the member outcomes assessment

requirements (see paragraphs 2.2.16 to
2.2.18).
1.4.5

1.4.6

1.4.7

While it will depend on the terms of a
specific registered managed investment
scheme, given the commercial context ofthe establishment of many schemes, it islikely that the purpose of many schemes
will be determined to comprise wholly or
partly the generation of a financial return
to members, and that the best interests ofmembers for the purposes of this duty will
also be, in many cases, the best financial
interests of members.
The enquiry as to whether the responsible
entity of a registered managed investment
scheme or APRA-regulated trustee ofa superannuation funds has acted in
the best interests of the members is anobjective one. Although a responsible
entity is required to act in the bestinterests of members; it is not required
to actually achieve the best outcome formembers.7 Consequently, there might bemore than one course of action that isin the best interests of the beneficiaries.8
Certain Australian commentators point toa line of cases that indicate that Australian
courts ‘will be loathe’ to review the meritsof a trustee’s decision unless the decision‘is so remarkable’ that it amounts to ‘one
which no reasonable trustee could make on thematerial before it’.9
The duty to act in the best interestsof beneficiaries does not necessarily
preclude the trustee from making adecision that might also provide benefits,
other than benefits to members (in that

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capacity), provided that the decision
has been properly made for the purposeof advancing the financial interests ofmembers (in that capacity).10
1.4.8

1.4.9

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Despite the need to consider financial risks
arising from climate change, legislation
introduced by the Commonwealth
Treasury, which has been passed by
the Federal Parliament and is awaiting
Royal Asset (before becoming law), is
likely to resolve any uncertainty about
whether ‘best interests’ means ‘best
financial interests’ with respect to therole played by APRA-regulated trustees
of superannuation funds. The legislation
provides that superannuation fund trustees
are required to exercise their powers andduties in the ‘best financial interests ofthe beneficiaries’.11 While this change
may not be inconsistent with the curialinterpretation of ‘best interests’ in thecontext of superannuation funds, it may
place an even greater focus on the financial
considerations applicable to decisions to
be made by superannuation fund trustees
and may result in superannuation fundtrustees being more reluctant to Invest for
Sustainability Impact.
In the same legislation the Superannuation
Industry (Supervision) Act 1993 (Cth) (SIS
Act) is to be amended to require APRA to
conduct an annual performance test for
MySuper products and other products
to be specified in regulations. A trustee
providing such products will be required
to give notice to its beneficiaries who holda product that has failed the performance
test.12 By assessing and rating trustee
performance on investment returns (andother, unlisted APRA requirements), it ispossible that trustees may focus on shortterm investments, resulting in positive
yearly returns rather than investments
focused on positive Sustainable Impacts.
Insurance companies and listed investmentcompanies
1.4.10 Standards applying to insurancecompanies and listed investmentcompanies are also often expressedreferring to duty to act in the ‘best interests’of the company. As discussed throughout
this report, though the best interest of
beneficiaries is defined with reference
to their financial interest, this may notnecessarily preclude.
1.4.11 The best interests duty in subsection
181(1) of the Corporations Act 2001
(Corporations Act) reflects the duty to
act in the best interests of the company
at general law. To discharge the bestinterests duty at general law, directors
must ‘exercise an active discretion andactually consider and act in the interestsof the company as a whole’.13 The test
is whether ‘an intelligent and honest
director could, in the whole of the existing
circumstances, have reasonably believedthat the transaction was for the benefit of
the company’.14
1.4.12 The traditional position has been that theinterests of the company are synonymouswith the interests of the shareholders as
a general body.15 Alongside the traditional
approach, sit a range of decisions focusedon the pursuit of short-term profit
maximisation for shareholders.16 However,more recently, some courts,17 a legislative

committee,18 and academics19 have endorsed
the view that the best interests duty is
better articulated as a duty owed to thecompany as a separate legal entity. Though
the interests of shareholders will generally‘intersect’20 or be ‘contiguous’ 21 with thoseof the company, the duty is not a duty toadvance the interests of shareholders.22
1.4.13 Additionally, recent cases suggest thatthe ‘best interests’ of a company are notnecessarily the maximisation of shortterm profits. According to one recent
High Court case, directors should consider
broader non-economic interests – or the‘commercial context’23 of a company —when determining what would serve
the best interests of a company. In ASICv Cassimatis, Edelman J (now a Justiceof the High Court) observed that whencalculating harm caused by a breachof a director’s duty of care, skill anddiligence non-financial factors, including
a company’s ‘reputation’, were relevant.24
Another recent decision also categorised‘community’ interests as interests which
may be adversely affected by director’s
actions.25 Case law also suggests that
directors may, when making decisions,consider other interests alongside abenefit to the company: ‘the law permits
many interests and purposes to beadvantaged by company directors, as longas there is a purpose of gaining in thatway a benefit to the company’. 26 This is
supported by two Commonwealth inquires
which found that under the best interest
duty directors can consider environmentalsocial and governance interests andfactors.27 These developments indicate

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that if non-financial considerations could
be reasonably regarded as one which
will benefit the company (in the shortor, perhaps, long-term) a director may
consider such other interests whilst
discharging their best interest duty.
These developments also indicate thatit may be possible for companies toengage in instrumental and ultimate ends
IFSI. Whether they can engage in any
particular instrumental or ultimate ends
IFSI will depend on the applicable facts
and circumstances at the time and theextent to which the investment or activity
can be regarded as being in the bestinterests of the company (whether because
it advances the financial or other interestsof the company, or because the financial
or other interests of the company arebeing advanced in parallel with the IFSI).
1.4.14 Relevantly and consistently with therecent curial trends referred to inparagraphs 1.3.13 to 1.3.14, the Interim
Report of the Royal Commission into
Misconduct in the Banking, Superannuation
and Financial Services Industry, included thefollowing remarks by the Commissioner,
Kenneth Hayne AC QC, who is former
Judge of the High Court of Australia:‘As [a commercial enterprise], [a listed] entity… rightly pursues profit. Directors and otherofficers of the entities owe duties to shareholders
to do that. But the duty to pursue profit is one
that has a significant temporal dimension. The
duty is to pursue the long-term advantage of theenterprise.
Pursuit of long-term advantage (as distinct
from short-term gain) entails preserving andenhancing the reputation of the enterprise as

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engaging in the activities it pursues efficiently,
honestly and fairly …
But to preserve and enhance a reputation forengaging in the enterprise’s activities efficiently,
honestly and fairly, the enterprise must do morethan not break the law. It must seek to do ‘theright thing’.
1.4.15 Hayne J also stated, extra-judicially, that:[what is in a Company’s] ‘Best interests’ is not
one-dimensional – it is not determined onlyby share price movement or ‘total shareholder
return’ over a period… in Australia, a director
acting in the best interests of the company musttake account of, and the board must reportpublicly on, climate–related risks and issues
relevant to the entity.28
1.4.16 Essentially, although the concept of IFSI
is not expressly mentioned by Kenneth
Hayne J in relation to his final report for
the Royal Commission, it can be strongly
inferred that Mr Hayne is making a strong
case that instrumental IFSI can overcome
systematic risks. An interpretation ofHayne J’s statements can be made thatsetting social impact goals and creating
a culture of ‘doing the right thing’ canultimately lead to improved financial
performance through the removal ofsystematic risks. In this regard, ESG is notjust a topic to be considered by the boardof companies, but instrumental IFSI isin the best interests of members since it
can, over the longer term, help produce a
better financial position.

1.4.17 The views of Hayne J have also beenechoed by other commentators in thecontext of public discussions involving
Australia’s corporate regulators andother key stakeholders, and appears to beconsistent with modern legal commentary.
Recently, Professor Baxt AO observedthat ‘in light of recent public pressure,somewhat enhanced by the operationsof bodies such as the ASX Corporate
Governance Council amongst others, thereis clearly an expectation that directors
should act with a greater awareness ofthe broader social context that impact on
the affairs of any company’.29 In a similarvein, Acquaah-Gaisie submits that ‘[c]orporate governance should focus not only
on profitability. Boards should promoteinterests of all corporate stakeholders’.30
In 2001, Horrigan argued that:‘[T]he best interests of a corporation…need not
be exclusively framed in financial or continuous
profit-maximisation terms…[They] are multidimensional, reflecting a variety of economic
and non-economic factors such as maintaining
industry standing, accommodating business‘best practice’ guidelines, and enhancing a
corporation’s community reputation.’31
Duty of care
1.4.18 Trustees and directors of companies are
generally subject to some form of duty ofcare and diligence.32
1.4.19 In determining the scope of the dutyof care and diligence of a trustee(which applies similarly to directors ofcompanies), the courts will have regard to:

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GLOSSARY• the circumstances of the trustee’s position

and the trust, including the type of

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the undertaking, the provisions of therelevant constituent documents, the size
and nature of the trustee’s operations,the functions to be performed, theexperience or skills of the trustee and thecircumstances of the specific case;33• the purpose of the particular power being

exercised or duty being carried out; and34• the prism of the particular trust inquestion, having regard to its constitution
and particular investment mandate,
and the profile of the accepted risks
and potential returns the subject of theinvestments that may be undertaken for
the trust. A trustee is not required toeschew a high-risk investment strategy
where that is the nature of the trustthat has been marketed to beneficiaries.
Rather, a trust is required to implement
the advertised strategy prudently.35
1.4.20 In order to discharge this duty of careand diligence, amongst other things,
the relevant person is required to haveregard to foreseeable risks of harm to thebeneficiaries or company’s (as applicable)interests (predominantly financial, but inthe case of companies, possibly broader
reputational and other interests) andconsider what steps a reasonable personin their position would take in thecircumstances to alleviate those risks.36
In determining what steps such areasonable person would take, the court
may have regard to the likelihood of
the risk occurring, the magnitude of
the risk and the seriousness of harm
the beneficiaries or the company (asapplicable) would suffer and the expense,

157

difficulty and inconvenience of taking
the applicable steps.37 Whether at law
a reasonable person is responsible forthe harm suffered may depend on thewhether the failure to discharge the dutyof care and diligence caused or materiallycontributed to the harm.38
1.4.21 Negative Sustainability Impacts
could conceivably be or intersectwith foreseeable risks of harm to
those interests, which engagement in
instrumental IFSI could alleviate (eg bytaking steps to influence the exposure ofinvestees of the person to those negative
Sustainability Impacts). Whether the
relevant person is required to take any orcertain steps and engage in instrumental
IFSI in those circumstances will depend on
what a reasonable trustee or director of acompany would do to alleviate those risks.
Doctrine of powers
1.4.22 The general law doctrine of powers
requires that donees of powers (including
trustees and directors) exercise theirpowers for a proper purpose.39 The
Australian courts have interpreted
a proper purpose to mean, namely,a purpose for which the power was
expressly or impliedly granted.40 An
exercise of a power for a purpose otherthan a proper purpose is voidable as afraud on the power.41
There does not appear to be a consistentline of curial authority as to how
significant collateral or incidental benefits
need to be to invalidate an exercise of
the power. However, it is clear that an

intention to secure collateral benefits
need not be the sole or dominant purpose
behind the exercise of the power for the
court to intervene.42 According to Donald,
Ormiston and Charlton, the apparent
consensus is that the courts will notintervene unless they believe the decision
was in fact influenced by the incidental
purpose or purposes to the detriment of
the beneficiaries.43
1.4.23 The discussion above on the generallaw principles of the doctrine of powers
also applies to the exercise of powers
by the directors of the boards of listed
investment companies (LIC) and insurancecompanies. That is, the directors of
LICs must exercise their management
and other powers consistently with the
purposes for which they were conferred.44
The duty is also reflected in the
Corporations Act.45
1.4.24 The law on doctrine of powers suggeststhat donees of powers may be constrained
from having parallel or significant
subsidiary purposes that are not the
purposes for which the relevant poweris granted. We note that the law on
the doctrine of powers may not in all
respects be consistent with the law on
the ‘best interests’ duty (see 1.4.13) orthe ‘sole purpose’ test that applies tosuperannuation funds (see 2.2.15). While
we cannot say how that inconsistency
would be resolved in all scenarios, weconsider it possible that if it were tested,a court may ultimately determine that,provided it could be said that the applicable
power had been exercised for a ‘proper
purpose’ (whether because the ‘proper

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purpose’ was the primary purpose, because
it would not have exercised but for that‘proper purpose’ or otherwise), the exerciseof the power would not be invalidated bya subsidiary or even parallel sustainability
purpose (ie ultimate ends IFSI).
1.4.25 The uncertainty as to whether thedoctrine of powers would allow ultimate
ends IFSI may not similarly constrain
instrumental IFSI, which contemplates thesustainability goal as being a necessary
step in achieving the relevant financial
investment objective, which may beconsistent with the purposes for which
the power was granted.

Statutory requirements
1.4.26 There are a number of federal statutes
that apply to all Relevant Investors thatinteract with the principle of IFSI. Principal
among these is the Anti-Money and CounterTerrorism Financing Act 2006 Cth (AML/CTF
Act) and the Modern Slavery Act 2018 (Cth)(Modern Slavery Act). The AML/ZTF Act
requires that an entity’s AML/CTF programaccommodates new and existing sanctions
against countries, goods and services,people or entities. The Modern Slavery Act
is a self-as sessment regime the reportingof which commenced in the second halfof 2020. It does not prescribe penalties orother liabilities for negative Sustainability
Impacts that are identified in the Modern
Slavery Act. However, in time, it isanticipated that the reporting requirements
will give rise to heightened public
expectations that APRA-regulated trustees
and insurance companies actively engage
with their Investment Managers to reduce
modern slavery risks in their portfolios.

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A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
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2.

ASSET OWNERS’ USE OF POWERS OF INVESTMENT AND DIVESTMENT TO INVEST FORSUSTAINABILITY IMPACT

2.1

The following section considers the extent
to which and in what circumstances, eachtype of Asset Owner is by law (a) required,or (b) permitted or able, to use its powers
of investment and divestment to Invest for
Sustainability Impact.

2.2

Pension funds

Types of pension fund covered
2.2.1

2.2.2

2.2.3

159

We consider below both accumulation anddefined benefit plans in superannuation
funds regulated by APRA under the
SIS Act. We have excluded fromconsideration: (a) superannuation funds
that have fewer than 5 members and aremanaged by a trustee regulated by APRA(‘small APRA funds’); (b) self-managedsuperannuation funds that have fewer
than five members and are personallymanaged by the members themselves and(c) superannuation funds for the benefitof state or federal Government employees
or members of the Australian Defence
Force, to the extent these funds are also
regulated by other Australian legislation.46
Superannuation funds are required to
be structured as trusts and do not haveseparate legal personality.
APRA-regulated trustees are required
to hold an Australian Financial Services
Licence (AFS Licence) issued by theAustralian Securities and Investments
Commission (ASIC), where thesuperannuation fund is a ‘public offer
fund’ or where the APRA-regulated trustee
engages in activities regulated by ASIC.

A ‘public offer fund’ is a superannuation
fund that individuals can join as members
without being nominated for membershipby their employer.
2.2.4

Superannuation funds are required
to maintain an investment portfolio,
referred to as a ‘MySuper product’ towhich contributions of their members
are allocated if a member has not
submitted a written investment direction.
Superannuation funds are also permitted
to offer other investment options(referred to as ‘choice products’) thatmembers may choose to invest in.
Almost all superannuation funds offer
members a facility to select from a list of
choice products.
• Asset Owner: The trustee of thesuperannuation fund.
• Beneficiaries: Members of thesuperannuation fund have a beneficial
interest in the fund. Other parties that may
receive a benefit in certain circumstances
include the member’s spouse, children
or person with whom the member has
an interdependency relationship,47 or
the member’s estate. For an employer
sponsored defined benefit superannuation
fund, the trustee may also need to consider
the position of the employer.
• Investment decision maker: The trusteeof the superannuation fund, or aninvestment manager appointed by thetrustee of the fund. An APRA-regulated
trustee must formulate and give effectto an investment strategy.48 One or moreinvestment managers may be appointed
to carry out some or all of the investment
management function.
Overview of investment duties and powers
Sources of legal duties and powers for APRAregulated trustees
2.2.5

2.2.6

Superannuation funds are principally
regulated by the SIS Act and statutory
instruments made under the SIS Act,
including prudential standards issued
by APRA (Prudential Standards).
Prudential Standards have legal effect as
statutory instruments.
Other sources of legal duties and powers
in relation to investment are:• legislation of the States and Territories

of Australia that applies to trustees49 (theState Trustee Acts): An APRA-regulated
trustee is subject to the State Trustee
Act in the State or Territory that is thegoverning law of the trust instrument
establishing the superannuation fund.
An APRA-regulated trustee may also be
subject to the State Trustee Act of otherStates and Territories in which membersof the superannuation fund reside;• general law: The law of trusts inAustralia remains substantially governedby principles of common law andequity (general law), which are foundin decisions of the Federal, State andTerritory courts. Statutory rules havesignificantly overlaid and modified the law

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B. THE EXTENT TO WHICH
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funds and APRA-regulated trustee, but
the general law remains applicable tothe extent that it is not overridden or
modified by statute; and• other legislation applicable to an APRA-

regulated trustee’s business of managing
the superannuation fund, for example: theCorporations Act, Modern Slavery Act and
AML/CTF Act.
2.2.7

Other regulatory sources for APRAregulated trustees include:(a) Prudential Practice Guides and otherpublications issued by APRA, setting out
APRA’s views on the interpretation of
relevant statutes and trustees’ duties; and(b) Regulatory Guides and other publications
issued by ASIC, setting out ASIC’s views on
the interpretation of the Corporations Act.
2.2.8

Prudential Practice Guides and Regulatory
Guides are normally not legally binding,but they represent APRA’s and ASIC’s viewon the law.

The power of investment for APRA-regulated trustees
2.2.9

A trustee’s power to invest the trust
property is derived from the generallaw of trusts but is now substantiallyregulated by statute, in particular theState Trustee Acts. Trustee legislation
includes similar terms in relation toinvestment powers and duties across all
States and Territories.

2.2.10 Under trustee legislation a trustee unlessexpressly forbidden by the trust instrument,
may invest trust funds in any form ofinvestment, and at any time vary an
investment or realise an investment

160

and reinvest money resulting from therealisation in any form of investment.50
These rules apply to APRA-regulated
trustees and superannuation funds.
As a result, while the trust instrumentof the fund may include a list of
authorised investments, trustees are notlimited to the listed investments unlessthe trust instrument expressly prohibits
other investments.
SIS Act general covenants and investment covenants
2.2.11 In brief summary, an APRA-regulated
trustee is required to:51• ensure that the superannuation fund ismaintained solely for prescribed purposes,
which are, broadly: providing benefits
from the superannuation fund, to themember on the member’s retirement or
attaining the age of 65, or the member’s
dependants or estate on the member’s
death (and benefits in other limited
circumstances) (the sole purpose test);52• formulate, review regularly and giveeffect to an investment strategy for thewhole superannuation fund, and each
investment option offered, taking into
account a list of prescribed factors.53
The prescribed factors include: risk andreturn having regard to investment
objectives and expected cash flow
requirements; composition and adequacyof diversification; liquidity having regard
to expected cash flow requirements;
reliability of valuation information;
existing and prospective liabilities and tax
and costs;54• exercise, in relation to all matters affecting

the fund, the same degree of care, skill
and diligence as a prudent superannuation
trustee would exercise in relation to anentity of which it is trustee and on behalfof the beneficiaries of which it makes
investments.55 A superannuation trustee
is ‘a person whose profession, businessor employment is or includes acting asa trustee of a superannuation entity andinvesting money on behalf of beneficiariesof the superannuation entity’;56• perform the trustee’s duties and exercise

the trustee’s powers in the best interestsof the beneficiaries;57• where there is a conflict of interest,

amongst other things, give priority
to the duties to and interests of thebeneficiaries;58 and• formulate, review regularly and give effectto a risk management strategy that relates
to: the activities, or proposed activities, ofthe APRA-regulated trustee, to the extent
that they are relevant to the exercise of
the trustee’s powers, or the performanceof the trustee’s duties and functions,as trustee of the superannuation fund;and the risks that arise in operating thesuperannuation fund.59
2.2.12 The directors of an APRA-regulated trustee
themselves owe the duty of care andskill and the best interests duty to thebeneficiaries of the superannuation fund.60
2.2.13 Specific statutory duties and obligations
that prescribe the investment approachthat an APRA-regulated trustee must adopt
were introduced in 2019.61 These include:

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product or a choice product, in particular
returns to those beneficiaries (after the
deduction of fees, costs and taxes);62• the obligation to undertake an annual

assessment, for each MySuper product andchoice product, of whether the financial
interests of the beneficiaries who holdthe product are being promoted by thetrustee, taking into account prescribedfactors including comparisons with otherfunds (member outcomes assessment).
The prescribed factors include: fees andcosts that affect the return; the return forthe product (for MySuper products, after
the deduction of fees, costs and taxes);• the level of investment risk; whether the

options, benefits and facilities offered
are appropriate to those beneficiaries;
whether the investment strategy for the
product, including the level of investment
risk and the return target, is appropriate
to those beneficiaries;63 and• the obligation to include in theinvestment strategy for MySuper
products an investment return target
over a period of ten years for the assets
comprising the MySuper product and thelevel of risk appropriate to the investmentof those assets.64
Sole purpose test
2.2.14 There is general acceptance of the
proposition that the sole purpose test
requires that investment decisions are
confined to the interests of members
in respect of their benefits from thesuperannuation fund, and not their161

interests in any other capacity.65
2.2.15 However, as with the best interests test,
Australian courts have held that thesole purpose test does not necessarily
preclude the trustee from making adecision that might also provide benefits,
other than benefits to members (in thatcapacity), provided that the decision
has been properly made for the purposeof advancing the financial interests ofmembers (in that capacity).66 Consequently,
it seems to us plausible that the sole
purpose test would not preclude the trusteefrom engaging in instrumental IFSI (andpossibly even ultimate ends IFSI), provided
that the relevant investment, activity or
decision is and could be characterised as aninvestment, activity or decision properly
made for the purpose of advancing thefinancial interests of members.67
Member outcomes assessment
2.2.16 Since January 2020, APRA Prudential
Standard SPS 515 – Strategic Planning andMember Outcomes (SPS 515) has required
APRA-regulated trustees to assess whether
they have, or will, provide the outcomesthat they seek to provide to beneficiaries,
and whether and how those outcomes
could be improved. We note that, in SPS
515, APRA does not indicate whether
those outcomes are necessarily financial,although given the duties that apply tosuperannuation trustees, we expect
those outcomes generally to be financial
in nature. The outcomes assessment
must include:68• the outcomes that the trustee seeks toprovide to beneficiaries;• the metrics that the trustee uses inundertaking its assessment to measure theoutcomes being provided to beneficiaries,
including their calculation;• a comparison of the calculation of thosemetrics with reference to objective
benchmarks and targets in both absoluteand relative terms; and• tthe key factors identified by the trustee

as having affected the results of those
calculations, which must include a listof prescribed factors, including theinvestment strategy of each investment
option and the basis for setting fees, andalso non-investment features including
insurance and the options, benefits andfacilities offered to members.
APRA Information Paper – Heatmap MySuper
products
2.2.17 APRA released an APRA Information Paper
titled ‘Heatmap – MySuper products’ on 15
November 2019 (APRA Heatmap Paper).
The APRA Heatmap Paper describes thedetermination and operation of (broadly,
financial) metrics that APRA has formulated
to assess the performance of MySuper
products offered by superannuation funds,
based on data that APRA collects fromthem. The metrics include:• investment performance (net investment

return, risk adjusted) over three and five
year timeframes; and• sustainability including net cash flow

and accounts growth rate. Use of theterm ‘sustainability’ refers to the ongoing
viability of the superannuation fundand the APRA-regulated trustee’s ‘likely

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
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Netherlands

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ability to continue to deliver quality
member outcomes into the future’ (ie, theterm refers to sustainability of member
outcomes). APRA expresses the view thatthe scale of a superannuation fund can
influence an APRA-regulated trustee’s‘ability to optimise investment outcomes’.69
2.2.18 Superannuation funds’ MySuper products
will be assessed on the metrics and theresults published at least annually on
APRA’s website. There is an expectationthat superannuation funds that are
identified as ‘underperforming’, based on
the published results, will face increased
pressure to merge with funds that havesuperior scores.70
AFS Licences for APRA-regulated entities
2.2.19 As a holder of AFS Licence, an APRAregulated trustee is subject to specificstatutory duties with respect to thefinancial services it provides. It is also notpossible to contract out of these duties.
The duties include the duty to:71• do all things necessary to ensure that theservices are provided efficiently, honestly
and fairly;• comply with financial services laws;• maintain the competence to provide

those services;• ensure that its representatives areadequately trained and are competent toprovide those services; and• have adequate risk management systems.

2.2.20 The ‘efficient’ in the duty to do all things
necessary to ensure that the services areprovided efficiently, honestly and fairly

162

includes the duty to ensure that the services
are adequate, produce the desired effect,
and are provided capably and competently.72
Timeframe for net returns
2.2.21 For APRA-regulated trustees, the duty
to treat different classes of beneficiaries
fairly may require balancing the interestsof younger members (who will be
invested in the superannuation system
for some decades) and the interests ofolder members with shorter investment
horizons. Some superannuation funds
approach this by implementing a‘life-cycle strategy’ for the MySuper
product, which has a higher weighting
to growth assets for younger age cohorts
and a progressively higher weighting to
defensive assets for older age cohorts.
Most superannuation funds offer choiceproducts that are weighted to lower
volatility assets than the MySuper
product, and these investment options are
typically marketed as aimed at members
who prefer a lower risk option.
2.2.22 The appropriateness of APRA-regulated
trustees taking into account net returns
over the longer term when making
investment decisions is supported bytheir statutory obligations to include ten
year investment return targets in theinvestment strategy for MySuper products,
and to publish ten year investment
returns for MySuper products. The APRA
Heatmap Paper also indicates that APRA
proposes to also assess the investment
performance MySuper products over sevenand ten year timeframes when the data
becomes available.

Statutory disclosure requirements applicable to
APRA-regulated superannuation trustees

ACKNOWLEDGEMENTS

2.2.23 A product disclosure statement (PDS)
must be given to new or prospective
investors in prescribed financial
products, including superannuation
funds, insurance policies and interests inregistered managed investment schemes.
The PDS must include any informationthat might reasonably be expected tohave a material influence on the decisionof a reasonable person, as a retail client,
whether to acquire the product.73 The PDS
for an investment product must include‘the extent to which labour standards
or environmental, social or ethicalconsiderations are taken into account in
the selection, retention or realisation of
investments’74 (ESG statement).

EXECUTIVE SUMMARY

2.2.24 ASIC Regulatory Guide 65 ‘Section 1013DA
disclosure guidelines’ (issued November2011) (ASIC RG 65) sets out detailed
guidelines for ESG statements and, unlike
other regulatory guides issued by ASIC,
which contain ASIC’s interpretationof the law but are not legally binding,the disclosure requirements in ASIC
RG 65 are mandatory.75 However, in
2011, amendments were made to allow
superannuation products and simple
managed investment schemes to provide
their ESG Statements in ‘summary form’.76
Nevertheless, ASIC strongly encourages
the use of ASIC RG 65 by entities when
they prepare a summary form PDS.77

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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Legal requirements to use investment powers to
Invest for Sustainability Impact
2.2.25 There is no general and explicit obligation
for APRA-regulated trustees to use
investment powers to Invest for
Sustainability Impact, and this applies
to both instrumental or ultimate ends
IFSI. Neither are there more specificrequirements for APRA-regulated trustees
to invest in such a way as to advancea secondary objective (for example, areduction in greenhouse gases) or that
preclude investment in certain industries
on the basis of sustainability or to seek tosecure wider societal objectives (outside
the objective to provide for the retirementof the member) or by reference to any‘public interest’.

to properly discharge their duties(particularly the best interests duty andthe duty of care and diligence), they
are required to consider financial risks
that may arise from climate change.
For example, in APRA’s Information
Paper Climate change: Awareness to action
release on 29 March 2019 (APRA Climate
Paper), APRA’s commentary included
that it expected APRA-regulated entities
to actively assess climate change andincorporate that assessment into theirgovernance frameworks, and that it will
be embedding assessment of climate risk
into its ongoing supervisory activities.80

2.2.26 However, there is legal academic andpractitioner commentary that suggeststhat proper risk management andconsideration of long term returns
may import an active duty for APRAregulated trustees to consider how
negative Sustainability Impacts may
impact investment performance, on thebasis that failure to do so may result in
financial losses to the superannuation
fund or not meeting the investment
objectives.78 Also, APRA-regulated trustees
are required to formulate and give effectto risk management strategies and APRA
has stated that it expects regulated
entities to actively assess climate change
risk and incorporate the assessment into
governance frameworks.79

2.2.28 The requirements in the APRA Climate
Paper are further reflected in the McVeighsettlement, where a fund member
commenced litigation for the trustee’s
failure to adequately handle climatechange risk. The settlement reflects theinitiative trustees should take, discharging
their duties whilst actively considering
climate change risk. Further, in a media
statement, the trustee of the relevantsuperannuation fund stated that as aresult of the case, the superannuation
fund would aim to implement strategies
to achieve a net zero carbon footprint
for the fund by 2050 and enhance its
considerations of climate change risks
when setting its investment strategies andasset allocation positions.81In this regard,
the response by the superannuation
fund in the McVeigh case is more akin to
ultimate ends IFSI.

2.2.27 APRA commentary also suggests thatin order for an APRA-regulated trustee

2.2.29 While APRA-regulated trustees are
not required to report on or disclose163

the Sustainability Impacts of theirportfolios, they are required to makecertain disclosures about ESG-related
matters (see paragraphs 2.2.23 to 2.2.24).
Where a PDS states that labour standards
or environmental, social or ethicalconsiderations are taken into account,and the APRA-regulated trustee is either
then required to invest the portfolio in
accordance with the disclosure, or if it
subsequently changes the policy, thiswould need to be notified to Beneficiaries.82
Legal freedom to use investment powers to Invest for
Sustainability Impact
2.2.30 An APRA-regulated trustee must comply
with its statutory duties83 when using
its investment powers. These duties
require an APRA-regulated trustee toprioritise financial returns. This meansthat in general, an APRA-regulated
trustee would not be permitted to selectstocks for a portfolio by reference totheir Sustainability Impact alone but
generally would be permitted to selectstocks for a portfolio by reference totheir Sustainability Impact in addition totheir contribution to investment return,if the selection offers an appropriate
risk-adjusted return (as determined by thetrustee) and or is otherwise justifiable as
described in paragraph 1.4.7 (ie ultimate
ends IFSI).
2.2.31 We note that the conceptual net of
IFSI includes undertaking the relevant
investment activities with the intention
to increase positive and/or reduce negative
Sustainability Impacts. It is entirely possiblethat an APRA-regulated trustee could

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

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FranceJapan

Netherlands

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United States

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undertake instrumental IFSI for the sole
purpose of providing a financial benefit(ie a source of income) to the member
upon retirement.
2.2.32 The SIS Act expressly recognises that for a
Choice product, an APRA-regulated trustee
may offer a range of investment options,and must develop an investment strategy
for each option taking into accountprescribed factors such as risk and return
having regard to the objectives of theoption. This implicitly recognises that an
APRA-regulated trustee may offer a range
of investment options having different
objectives, with corresponding different
investment strategies taking into accountthe risk and return profile of the option
determined by the objectives.
2.2.33 This freedom is also supported by APRA
commentary, in Prudential Practice Guide
SPG 530 Investment Governance (November2013) (SPG 530) which states:
An [APRA-regulated trustee] may takeadditional factors into account where there isno conflict with the requirements in the SIS Act,
including the requirement to act in the bestinterests of the beneficiaries. This may result inan [APRA-regulated trustee] offering an ‘ethical’
investment option to beneficiaries to reflect
this approach. An ‘ethical’ investment option
is typically characterised by an added focus
on environmental, sustainability, social andgovernance (ESG) considerations, or integrates
such considerations into the formulation of theinvestment strategy and supporting analysis.84
2.2.34 In all circumstances an APRA-regulated
trustee looking to select assets for a
portfolio by reference to those assets’164

Sustainability Impact would be generally
limited to Sustainability Impact
opportunities that offer an appropriate
risk-adjusted return (as determined by the
APRA-regulated trustee taking accountof all the factors it considered relevant)or where their selection is otherwise
justifiable as described in paragraph 1.4.7.
(that is, instrumental or ultimate ends
IFSI where the investment decision can bejustified on purely financial grounds).
2.2.35 Where an APRA-regulated trustee
decides that an environment, socialand governance or socially responsible
investing investment option should be
added to the selections available to theirmembers, the APRA-regulated trustee
remains responsible for the design ofthe relevant investment option, and isrequired to determine the investment
objectives and other design features inaccordance with their duties.
2.2.36 For a superannuation fund’s MySuper
product, an APRA-regulated trustee is not
permitted to select stocks by reference
to their Sustainability Impact instead of
their contribution to investment return,unless the selection of the particular stock
can be justified in accordance with theinvestment strategy (for example, on the
grounds of diversification) taking into
account the overall portfolio composition
and risk / return objectives. All stocks
acquired for the MySuper product must be
consistent with meeting the investment
objective of the product, but individual
stocks will typically have different returns
and may be selected for reasons suchas diversification and non-correlation(noting that the duties for formulating an
investment strategy include considerationof diversification as a separate prescribedfactor). For example, if there is aninvestment case that a company that turns
around its ESG credentials has a similar
improvement in its share price, then thetrustee could invest with an intention toincrease positive sustainability impacts forthe purpose of achieving financial returns.
2.2.37 Choice products are selected by members,
and the APRA-regulated trustee isrequired to give the member sufficient
information about a choice productso that they are fully informed of theinvestment objectives and strategy and therisk involved. It is arguable in principlethat there should be no objection or
impediment to a superannuation fundor an investment option that favours
Investing for Sustainability Impact being
available for selection by a member on a
fully informed basis.85 In that context, thestocks selected for that investment option
would meet the Sustainability Impact
criteria disclosed. However, the same legal
duties apply to all investment options, andultimately this means that APRA-regulated
trustees are required to prioritise financial
returns for all investment options. This
restricts their capacity to design and offer
investment options that have objectives
other than financial return. For ESG
investment options designed and offeredprior to introduction of the requirementthat all investment options must promote
the financial interests of members86, there
could be some risk that the Sustainability
Impact criteria for the investment option

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

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FranceJapan

Netherlands

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need to be reassessed to ensure that the
new requirement is met. Any materialchanges to the investment strategy or
portfolio composition resulting from thisassessment would need to be notified tomembers.87 In practice it seems likely that
APRA-regulated trustees will wait for the
updated APRA guidance in the revised SPG
2.2.38 530 that APRA has announced it intends
to provide88 before undertaking thisassessment (see paragraph 2.2.40).
2.2.39 The precedence of statutory duties whenan APRA-regulated trustee is using its
investment powers is unchanging even
if the trustee believes that Beneficiaries
share a concern that the portfolio isinvested for Sustainability Impact.
2.2.40 As SPG 530 was published before thestatutory requirement to promote thefinancial interests of MySuper members
was introduced,89 there is considerable
uncertainty as to whether an investment
option where Investing for Sustainability
Impact has priority to financial return
could be offered.90 At this stage it is notknown whether APRA will consider thatthe requirement will impose an obligation
to reflect Beneficiaries’ views on investingfor Sustainability Impact. APRA is also
currently undertaking a review of its
prudential practice standards with aview to responding to the heightened
expectations of members in terms of
performance outcomes, which has
already resulted in the introduction of a
new standard on strategic planning andmember outcomes (SPS 515).91 In that
context, APRA has announced it may

165

consider enhancements to its standards
and guidance ‘to provide clarity on the
obligations…. to take into account ESG
factors when setting their investment
strategies.’92
2.3

managed investment schemes is largely
justified by reference to the need toprotect the interests of ‘retail’ (as opposed
to wholesale) investors.93
2.3.4

Mutual funds

Types of mutual fund covered
2.3.1

In this Annex, the two common formsof retail investment funds (being anequivalent of mutual funds in thisjurisdiction) considered are registered
managed investment schemes and Listed
Investment Companies (LICs).

Registered managed investment schemes
2.3.2

2.3.3

A managed investment scheme is a vehicle
through which investors pool funds for
a common enterprise and to produce
financial benefits or benefits consistingrights or interest in property. Members
in a managed investment scheme do nothave day-to-day control over the operationof the scheme or its assets. While
managed investment schemes can be invarious legal forms, generally managed
investment schemes embody the basic
elements of trusts. Only those managed
investment schemes that are constituted
as trusts are included within the scope of
this report.
Managed investment schemes may beeither registered or unregistered. A
managed investment scheme must be
registered by ASIC if it has more than 20
members or it is promoted by a person
who (or whose associate) is in the businessof promoting managed investment
schemes. The registration system for

2.3.5

2.3.6

Registered managed investment schemes
must be operated by a ‘responsible
entity’ that manages the scheme inaccordance with the functions provided
to it by the scheme’s constitution and
the Corporations Act. A ‘responsible
entity’ for a scheme must be incorporated
as a public company and hold an AFS
Licence authorising it to operate managed
investment schemes.
Registered managed investment schemes
structured as trusts may also be listed,
allowing for interests in the scheme(units) to be tradeable on the Australian
Stock Exchange (ASX). Schemes thatare listed are subject to the listing anddisclosure rules that apply to LICs and theimplications of those rules as discussed
below in the context of LICs applies tolisted schemes.
The key entities are:
• Asset Owner: The responsible entity

operates the scheme and may hold legal
title to the assets of the scheme.
• Beneficiaries: The beneficiaries of ascheme are the members (or is thecase of schemes that are unit trusts,
the unitholders) of the scheme. It is
not considered that the meaning of‘beneficiaries’ in the context of a managed
investment scheme may be taken to
include future members.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

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FranceJapan

Netherlands

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investment-decision maker of the scheme
may be either the responsible entity
or an investment manager engaged by
the responsible entity. This investment
manager may or may not be a related
entity of the responsible entity.
Listed investment companies
2.3.7

LICs are investment funds that are
structured as public companies listed on asecurities exchange.

2.3.8

In Australia, as in other jurisdictions, LICs
are managed by or under the directionof its board of directors and invested inby shareholders. In addition to the rules
governing the creation, structure, andgovernance of public companies in the
Corporations Act, LICs must also operatein accordance with the ASX Listing Rules(Listing Rules).94

2.3.9

The key entities are:
• Asset Owner: The LIC owns theunderlying assets in its own right.
• Beneficiaries: The beneficiaries are

the shareholders of the LIC. It is
not considered that the meaning of‘beneficiaries’ in the context of a LIC may
be taken to include future shareholders.
• Investment decision maker: The LIC will

managed by or under the direction of its
board of directors. The LIC’s investment
activities may be managed either by its
board of directors or by one or more
external investment manager appointed
by its board of directors.

Overview of investment duties and powers –registered managed investment schemes
2.3.10 The primary source of a responsible
entity’s duties and powers is the
Corporations Act. As there is a trust
relationship between members of aregistered managed investment schemeand the responsible entity,95 a responsible
entity must also comply with theapplicable State Trustee Acts and duties
imposed by the general law on trustees(which broadly reflect the responsible
entity’s general duties under the
Corporations Act). While the responsible
entity’s duties under the applicable State
Trustee Acts and by the general law ontrustees will be subject to or informed by theterms of the constitution of the scheme,96
the statutory duties of the responsible entity
apply notwithstanding the terms of theconstitution of the scheme.97
2.3.11 The statutory duties imposed on
responsible entities under the
Corporations Act include the duties to:• exercise the degree of care and diligencethat a reasonable person would exercise
if they were in the position of the
responsible entity;• act in the best interests of the members,

and if there is a conflict between themembers’ interests and its own interests,
give priority to the members’ interests;• comply with the constitution of thescheme (to the extent that it is consistent
with the Corporations Act);• give priority to the members’ interestsin the event a conflict between such

166

interests and the responsible entity’s own
interests; and• carry out or comply with any other duty,

not inconsistent with the Corporations
Act, that is conferred on the responsible
entity by the scheme’s constitution.98
2.3.12 A responsible entity is also vested withpowers under the constitution of thescheme, being the document that governs
the legal relationship and is enforceable
between the responsible entity andthe members.99 The Corporations
Act prescribes certain content for
constitutions of registered managed
investment schemes.100 Relevantly,
a scheme’s constitution must makeprovision for ‘the powers of the responsible
entity in relation to making investments of, orotherwise dealing with, scheme property’.101
2.3.13 Typically, the constitution of the schemeor the product disclosure documentsof the scheme provided to members
and potential members will set out theinvestment objectives (including the target
financial return), investment strategy
and investment guidelines of the scheme.
Those objectives, that strategy and thoseguidelines will likely inform the content
of the responsible entities’ investment
duties and powers.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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Overview of investment duties and powers – listed
investment schemes
2.3.14 Directors of LICs are subject to the samelegal duties as other listed Australiancompanies, which arise from statutory
directors’ duties under the Corporations
Act, which overlap and codify aspectsof the general law fiduciary and other
equitable duties. Directors owe thoseduties to the company as a whole, and not
individual shareholders.102
2.3.15 Typically, the LIC’s investment duties andpowers are shaped by:• statutory duties contained in the

Corporations Act as they apply to directorsof Australian companies, including:• the duty to act with a reasonable degree ofcare and diligence;103• the duty to act in good faith and in thebest interests of a shareholders;104• the duty to exercise their powers anddischarge their duties for a proper
purpose;105• the duty not to improperly use theposition of director to gain an advantage
for the director or someone else, or cause
detriment to the corporation;106• the LIC’s constitutional documents (andother governing documents);• marketing documents given to investors(including prospectuses and otherdisclosure documents); and• the Listing Rules (or other relevantmarket rules).

167

Registered managed investment schemes
Legal requirements to use investment powers to
Invest for Sustainability Impact
2.3.16 We do not consider that responsible
entities have a legal obligation, generally,
to Invest for Sustainability Impact, andthis applies to both instrumental andultimate ends IFSI. Whether a particularresponsible entity of a scheme would
have such a duty will depend heavily on
the objective purpose of the scheme andits terms (which will be predominantly
set out in the constitution and disclosure
documents of the scheme).
2.3.17 However, responsible entities may, inorder to discharge their duty of care anddiligence, be required to have regard
Sustainability Impacts that present
foreseeable risks of harm to the value ofthe portfolio of the scheme and members’interests (which in most cases will likely
equate to the financial interests ofmembers as members) and consider andtake the steps a reasonable responsible
entity would take in the circumstances toalleviate these risks. That may, dependingon the circumstances (in particular theinvestment strategy of the scheme)
and for example, require a responsible
entity to exclude particular or classes
of investments that may have negative
Sustainability Impact on the value of theportfolio and the interests of members
as members (eg exclude investments thatare contrary to applicable law) or divest
such investments. Whether a responsible
entity would in fact have a duty to do
so will very much depend on what areasonable responsible entity would do in
the circumstances.
2.3.18 Having regard to the limited and specificinvestment strategies of registered
managed investment schemes, it isdifficult to conclude as a general matterthat responsible entities could be required
to engage in IFSI (whether instrumental
or ultimate ends). Whether a responsible
entity would be required to engage in IFSI
would very much depend on the specificterms of the registered management
investment scheme, the particular IFSI
being contemplated and other relevantfacts and circumstances.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

Legal freedom to use investment powers to Invest for
Sustainability Impact

ANNEXES

2.3.19 Whether or not a responsible entity has
the legal freedom to use its investment
powers to Invest for Sustainability
Impact will depend on the purpose of
the scheme and its terms (which will be
predominantly set out in the constitution
and disclosure documents of the scheme).

JURISDICTION REPORTS

2.3.20 Responsible entities will likely be required
to act in the best ‘financial’ interestsof members in evaluating investment
options and will generally only bepermitted to use their investment powers
to Invest for Sustainability Impact wherethat use is consistent with and does notadversely affect the overall financial
outcomes for and profile of the scheme(taking into account expected investment
return, risk, diversification, liquidity
and other characteristics of investments
made consistently with the Investingfor Sustainability Impact objective). This

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corresponds more closely with the concept
of instrumental IFSI, which necessarycontemplates that a financial objective
is being pursued. Where there areopportunities to Invest for Sustainability
Impact that are consistent with and do not
adversely affect the financial outcomes forand profile of the scheme, the responsible
entity may also need to consider any
additional due diligence, execution andreporting costs that may be borne by thescheme as result of pursuing and investingin those opportunities and whether
they are justifiable taking into accountthe contribution those opportunities
are expected to make to the financial
outcomes and profile of the scheme.
Listed investment companies
Legal requirements to use investment powers to
Invest for Sustainability Impact
2.3.21 The analysis above at paragraphs 2.3.16
to 2.3.18 with respect to schemes applies
broadly to LICs.
2.3.22 Further, we consider that it would be very
challenging for a shareholder to establish
a director of a LIC has breached its duty ofcare and diligence by failing to Invest for
Sustainability Impact. Under the so-called‘business judgment rule’, a director will
have acted with the degree of care anddiligence required by the Corporations
Act if the director has acted in good faith
for a proper purpose, and rationallybelieves the act is in the best interestsof the company.107 Notwithstandingthat it may be in the interests of thecompany to engage in IFSI (whether
instrumental or ultimate ends), it would

168

be difficult to argue that a director has
acted with an improper purpose by failingto prioritise long-term sustainability
considerations over the financial interestsof current shareholders. This defence
militates against a legal requirementon the directors of LICs to Invest for
Sustainability Impact.

fund policies disclosed by the LIC in its
formal disclosure documents. Given that
LICs are generally formed to generate afinancial return, the prioritisation of theselection of investments by reference totheir Sustainability Impact over theircontribution to investment return may
be viewed as an improper purpose andvoidable under the doctrine of powers
or the statutory duty not to act for
improper purposes, unless the selectionof those investments by reference to their
Sustainability Impact would otherwise
directly benefit the LIC. Certainly, if
instrumental IFSI, and achieving afinancial return through the elimination ofsystematic risks, were adopted as industrywide practice, the way that investing for
Sustainability Impacts could achieve along-term, sustainable financial goal would
likely receive greater recognition with
LICs. In addition, it is conceivable that,
if an investment decision could properly
be made in accordance with the terms of
the LIC and justified based on financial
considerations, it would be permitted,
notwithstanding the presence of anultimate ends IFSI motivation.

Legal freedom to use investment powers to Invest for
Sustainability Impact
2.3.23 Though the analysis at paragraphs 2.3.18
to 2.3.19 above in relation to schemes
applies broadly to LICs, LICs may havea greater legal flexibility to Invest for
Sustainability Impact.
2.3.24 The best interest duty may allow thedirectors of LICs to consider the interestsof the company more broadly, including
reputational interests.108 Directors mustalso be entrepreneurial in their approach(and as such can accept more commercial
risks that trustees and may be subject
to less scrutiny in their pursuit of the
LICs objectives).109 Certain investments
for Sustainability Impact – if made topromote the ‘reputation’ of the LICs, could
arguably be permissible.
2.3.25 By merit of LICs being structured ascompanies, the law governing the conductof directors has generally afforded
directors a greater degree of latitudewith respect to risk-taking than it has
to trustees110. The exact extent to which
this entrepreneurial discretion may be
used to prioritise Sustainability Impacts
is uncertain. Generally, however, theLIC will likely be constrained by theinvestment strategy statements and

2.4

Insurance undertakings

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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Australia

BrazilCanadaChina

European Union
FranceJapan

Types of insurance undertaking covered

Netherlands

2.4.1

South Africa

We consider in this report:• Life insurance companies (Life Insurers):

Life Insurers must be registered under
the Life Insurance Act 1995(Cth) (LifeAct). Life insurance policies are either‘investment-linked’, where the benefits
under the policy are determined by thevalue of the investments supporting

United Kingdom
United States

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the policy, or risk insurance where thebenefit is payable on the happening ofprescribed events (death or disability). Life
insurers may conduct ‘superannuation
business’, consisting of issuing policies
maintained for the purposes of asuperannuation or retirement scheme,and ‘ordinary business’ consisting of nonsuperannuation policies.

death of the policyholder the nominatedbeneficiary will receive the benefit, andfor Directors & Officers insurance anofficer of a company might receive a direct
benefit. Shareholders of Life Insurers
and General Insurers would also have an
economic interest in the management of
the assets of the entity.
• Investment decision maker: The• General insurance companies (General

Insurers): A General Insurer is a company
that provides forms of insurance otherthan life insurance, and to which theInsurance Act 1992 (Cth) (Insurance Act)applies. General insurers issue risk policies
only, where the policy holder is entitledto the specified insured amount on theoccurrence of the specified event covered
under the policy (ie the policy holder’sbenefit is not determined by investment
returns). General insurance broadly
includes forms of insurance covering
property or covering the insured’s
liabilities to other persons, such as motor
vehicle insurance, home and contents
insurance, commercial insurance,
professional indemnity insurance,
directors and officer’s liability insurance
and public liability insurance.
2.4.2

2.4.3

• Beneficiaries: Policyholders. People orother legal entities may also receive abenefit from the policy, for example,
for life insurance policies upon the

169

2.4.7

Overview of investment duties and powers
2.4.4

2.4.5

The key entities are:General Insurer.

Statutory obligations of Life Insurers

Life Insurer or General Insurer, or aninvestment manager appointed by therelevant entity.

Health insurance companies and State andTerritory accident insurance bodies are
not included here.
• Asset Owner: the Life Insurer orof financial institutions that arecompanies listed on the ASX. Therefore
returns to the insurance company that are
not required to support policy liabilities
may ultimately be for the benefit ofshareholders of listed companies.

2.4.6

Both Life Insurers and General Insurers
are regulated by APRA. They are also
required to hold an AFS Licence and are
subject to the specific statutory duties
that apply to AFS Licence holders.111
Insurance policies are contracts between
the insurer and the policy holder, andtherefore the obligation of the insurancecompany is to meet the terms of thecontract (the policy). For risk policies,
the key contractual obligation is to pay
the specified insured amount on thehappening of the prescribed insured
event. For investment-linked policies, theLife Insurer’s contractual obligations inrelation to management of the portfolio
depend on the terms of the policy asdrafted by the Life Insurer and acceptedby the policy holder. Insurance companies
are not trustees.
An insurance company’s shareholders
benefit from returns on the insurancecompany’s investments, to the extent thatthe returns exceed the assets required tomeet liabilities to policyholders. Insurancecompanies are in many cases subsidiaries

2.4.8

The principal statutory obligations that
apply to Life Insurers, in investing theassets of their statutory funds, are set out
in the Life Act and Life Insurance Regulations
1995 (Cth) (Insurance Regulations), andin Prudential Standards issued by APRA
(which, as noted in paragraph 2.2.5 above,
have legal effect as statutory instruments).
APRA also publishes Prudential Practice
Guides and other commentary andguidance material, which set out APRA’s
interpretation of statutory obligations
and APRA’s expectations, as a prudential
regulator, for the conduct of Life Insurers.
The principal statutory obligations under
the Life Act include:• Life Insurers are required to maintainstatutory funds for their insurance
business.112 The assets of the statutory
fund may only be applied: (a) to meet
liabilities (including policy liabilities) or
expenses incurred for the purposes of thebusiness of the fund; or (b) for the making
of investments as permitted; or for the
purposes of a permitted distribution.113• In the investment, administration andmanagement of the assets of a statutory
fund, a Life Insurer must give priority to
the interests of owners and prospective
owners of policies referable to thefund.114The requirement to give priority

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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to the interests of policy holders refers totheir interests as policy holders.115• Profits and losses of a statutory fundmay only be dealt with in accordancewith Divisions 5 and 6 of the Life Act (theobject of those Divisions being to ensurethat such profits and losses are dealt within a manner that protects the interestsof policy owners and is consistent withprudent management of the fund).116
2.4.9

The general rule regarding investmentof assets of a statutory fund is that a Life
Insurer may invest such assets in any way
that is likely to further the business ofthe fund.117

2.4.10 The Life Act does not prescribe substantive
powers of investment for shareholders
funds, and there are no express duties
in relation to the exercise of investment
powers for shareholders funds.
2.4.11 Directors of a Life Insurer have a duty
to the owners of policies referable to astatutory fund, to use reasonable care,and due diligence in the investment,
administration and management of
the assets of the fund, so that the Life
Insurer gives priority to the interests ofowners and prospective owners of policies
referable to the fund. In the event ofconflict between the interests of owners
and prospective owners of policies and theinterests of shareholders, a director’s duty
is to take reasonable care, and use due
diligence, to see that the Life Insurer gives
priority to the owners and prospective
owners of those policies over the interestsof shareholders.118

170

Statutory obligations of General Insurers
2.4.12 The principal statutory obligations that
apply to General Insurers are set out in
the Insurance Act, Insurance Regulations
and in Prudential Standards issued by
APRA. APRA also publishes Prudential
Practice Guides and other commentaryand guidance material which set out
APRA’s interpretation of statutory
obligations and APRA’s expectations, as aprudential regulator, for the conduct ofGeneral Insurers.
2.4.13 General Insurers are required under the
Insurance Act to hold assets in Australia(excluding goodwill and any other assets
or amounts excluded by Prudential
Standards) of a value equal to or greaterthan the amount of its liabilities inAustralia.119 A General Insurer commits
an offence under the Insurance Act
where the General Insurer does nothold sufficient assets in Australia. The
purpose of this requirement is to ensurethat the total value of assets held within
the jurisdictional reach of APRA and theAustralian courts is sufficient to meet a
General Insurer’s liabilities in Australia.120
2.4.14 Otherwise, the Insurance Act andInsurance Regulations do not prescribe
substantive powers of investment for
General Insurers, and there are no express
duties in relation to the exercise ofinvestment powers.
Risk management requirements for insurance companies
2.4.15 APRA Prudential Standard CPS 220 (RiskManagement) applies to Life Insurers andGeneral Insurers. The rules include: ‘An
APRA-regulated institution must maintaina risk management framework for the
institution that enables it to appropriately
develop and implement strategies,
policies, procedures and controls tomanage different types of material
risks, and provides the Board with acomprehensive institution-wide view ofmaterial risks.’121
2.4.16 The risk management framework
is required to address a list of risks,
including market and investment risk,
and liquidity risk, and also risks that,singularly or in combination withdifferent risks, may have a material
impact on the institution.
Capital adequacy requirements for insurance companies
2.4.17 A series of Prudential Standards
issued by APRA set out detailed andhighly prescriptive capital adequacy
requirements for Life Insurers andGeneral Insurers.122

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

Brazil

2.4.18 Complying with the capital baserequirements includes calculating theimpact of a range of risks, in accordancewith prescribed formulas, and theseinclude ‘stress-testing’ scenarios for
categories of assets held in the insurancecompany. The requirements are aimed atensuring that insurance companies at all
times have sufficient assets to cover their
liabilities to policy holders.

CanadaGeneral insurance: Legal requirements to use
investment powers to Invest for Sustainability Impact

United Kingdom

2.4.19 A General Insurer is not required to
select investments by reference to their
Sustainability Impact, and this applies toboth instrumental and ultimate ends IFSI,

China

European Union
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Netherlands

South Africa

United States

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either instead of or in addition to theircontribution to investment return.
2.4.20 However, general insurance companies
are required to formulate and give effectto risk management strategies and APRA
has stated that it expects regulated
entities to actively assess climate change
risk and incorporate the assessment into
governance frameworks.123
2.4.21 General insurance companies mustcomply with the capital adequacy
requirements set out by APRA in therelevant Prudential Standards.124 These
Prudential Standards include that there
must be a strategy for ensuring adequate
capital is maintained over time.125
2.4.22 As discussed in paragraphs 2.4.12 to
2.4.14 the directors of general insurancecompanies have a duty to act in the bestinterests of the company, and so to theextent that would require considerationof sustainability then this may create alegal imperative.
2.4.23 There is no requirement for generalinsurance companies to consider systemwide sustainability in how a generalinsurer approaches its investments, or toconsider the sustainability aspirations or
wider well-being of shareholders a
nd policyholders beyond the duties
already described.
2.4.24 Reporting under the Modern Slavery
Act has commenced in the second halfof 2020. As a self-assessment regime theModern Slavery Act does not prescribe
penalties or other liabilities for negative
Sustainability Impacts that are identified
in the Modern Slavery Act. However, in

171

time, it is anticipated that the reporting
requirements will give rise to heightened
public expectations that APRA-regulated
trustees and insurance companies actively
engage with their Investment Managers
to reduce modern slavery risks in theirportfolios or risk significant reputational
damage, potential loss of revenue or shareprice, and class actions from investors.
2.4.25 Further, APRA expects comprehensive
disclosure of climate change risks will
progress in the future.126
General insurance: Legal freedom to use investment
powers to Invest for Sustainability Impact
2.4.26 A General Insurer is permitted to use
its investment powers to Invest for
Sustainability Impact in addition tocontribution to investment return, if theselection of the investments is consistent
with the insurance company’s duties withrespect to shareholders. (See commentaryon directors’ duties to shareholders andthe company at paragraphs 1.3.11 to
1.3.17.)2.4.27 The investment-related duties of insurancecompanies make it difficult to selectstocks for a portfolio to the extent thatthe selection is solely for Sustainability
Impact reasons, unless the terms of thepolicy authorise selection on that basis(though we note this is very unlikely
to occur). However there should be no
difficulty imposed by those obligations inselecting stocks for Sustainability Impact
where there is no anticipated adverse
effect on financial returns or where theselection is consistent with risk mitigationor other financial considerations (such as

diversification or non-correlation).
2.4.28 A General Insurer is not precluded fromassessing the views of Beneficiaries on theextent to which they want the insurancecompany to Invest for Sustainability
Impact in managing portfolio assets. The
extent to which an insurance company ispermitted to reflect Beneficiary views on
Investing for Sustainability Impact in theobjectives of the portfolio is constrainedby their obligations to the policy holders
and to the insurance company’s own
shareholders.
Life insurance: Legal requirements to use investment
powers to Invest for Sustainability Impact
2.4.29 A life insurance company is not explicitly
required to select investments byreference to their Sustainability Impact,
and this applies to both instrumental
and ultimate ends IFSI, either instead ofor in addition to their contribution toinvestment return.
2.4.30 However, life insurance companies are
required to formulate and give effect torisk management strategies and APRA
has stated that it expects regulated
entities to actively assess climate change
risk and incorporate the assessment into
governance frameworks.127
2.4.31 As for general insurers, life insurancecompanies must comply with the capital
adequacy requirements set out by APRA
in the relevant Prudential Standards,128
which include that the life company musthave a strategy for ensuring adequate
capital is maintained over time129 and the
directors have a duty to act in the bestinterests of the company.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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2.4.32 In addition, the Life Act requires that alllife insurers maintain statutory funds
which hold, among other things, allpremiums received and income from theinvestment of the assets of the statutory
fund.130 In relation to the investment,
administration and management of theassets of a statutory fund, the Life Act
prioritises the interests of ‘owners andprospective owners’ of policies.131 In
particular the Life Act requires that where
there is conflict between the interests ofshareholders and the interests of owners
or prospective owners of policies, a
director’s duty is to take reasonable care,and use diligence, to see that the company
gives priority to the interests of owners
and prospective owners of policies overthe interests of shareholders.132
2.4.33 While life insurance companies are notrequired to report on or disclose theSustainability Impacts of their portfolios,
they are required to make certain
disclosures about ESG-related matters(see paragraphs 2.2.23 to 2.2.24). Life
Insurers (for investment-linked policies)
are required to include statementsin the PDS of the product (which are
given to new or prospective members)that specify the extent to which labour
standards or environmental, social or
ethical considerations are taken into
account in the selection, retention or
realisation of investments.133 Where a
PDS contains a disclosure about labour
standards or environmental, social or
ethical considerations, and the APRAregulated trustee or Life Insurer does
not implement the investment of
the portfolio in accordance with the172disclosure, or subsequently changes thepolicy, this would need to be notified to
Beneficiaries.134
2.4.34 Moreover, APRA also expects
comprehensive disclosure of climatechange risks will progress in the future.135
Life insurance: Legal freedom to use investment
powers to Invest for Sustainability Impact
2.4.35 A life insurance company is permitted
to use its investment powers to Invest
for Sustainability Impact in addition
to contribution to investment return,only if the selection of the investments
is consistent with the life insurancecompanies other duties. For example, thedirector’s duties to shareholders, policy
holders and prospective policy holders
described above. For investment-linked
business of Life Insurers, stock selection
must comply with the terms of the policy.
2.4.36 The investment-related duties of insurancecompanies make it difficult to selectstocks for a portfolio to the extent thatthe selection is solely for Sustainability
Impact reasons, unless the terms of thepolicy authorise selection on that basis.
However there should be no difficulty
imposed by those obligations in selecting
stocks for Sustainability Impact where
there is no anticipated adverse effect onfinancial returns or where the selection
is consistent with risk mitigation orother financial considerations (such as
diversification or non-correlation).
2.4.37 The position in relation to assessing andresponding to the views of Beneficiaries is
as for general insurance in paragraph 2.4.28.
2.4.38 For investment-linked policies, a Life
Insurer can take account of beneficiaryviews in constructing policy terms - that
is, Life Insurers can design an investment
portfolio that includes Investing for
Sustainability considerations or evenprioritising Sustainability Impact overinvestment returns, if they were theterms of the policy, as the Life Insurer’s
obligation is to comply with the termsof the policy as contractual obligations.
However, the Life Insurer would beconstrained from taking account ofbeneficiaries’ views by the terms of thepolicy, particularly for portfolios that havemultiple policy holders. Where the policy
is silent on Investing for Sustainability
Impact, the Life Insurer would notnecessarily be precluded from taking
account of beneficiary views, but equally
the Life Insurer would not be able toreflect them in the portfolio in a way thatwas inconsistent with the policy terms(including the policy’s stated objectives
and strategies). As the stated objectives
and strategies are normally expressed
as financial returns, the Life Insurer
would not be able to reflect the views ofindividual beneficiaries where this could
adversely impact financial returns.
2.4.39 Similarly an insurance company would
not be precluded from taking into accountthe non-financial impact of an investment
decision in which the portfolio is managed(provided that doing so is consistent withthe terms of the policy). While the duty
to give priority to the interests of policy
holders applies in respect of their interests
as policy holders only, a Life Insurer is notprohibited from acting in the interests ofother parties (including the Life Insurer’s
shareholders, but also including the policy

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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holders in other capacities) provided thatthe interests of policy holders in thatcapacity are prioritised. Life Insurers are
not subject to the sole purpose test or
the best interests duty, and they do nothave a statutory duty of care and skill
in relation to investments (although theLife Insurer would have a duty of care topolicy holders under the general law ofnegligence, and directors of Life Insurers
have a duty of care in relation to ensuringthat the Life Insurer meets requirements
for managing statutory funds). Therefore,
there may be some scope to consider the
Sustainability Impact in the managementof the portfolio, provided that this isconsistent with their duties to prioritise
the interests of policy holders.
2.4.40 For the superannuation business of Life
Insurers, the policy holder is the APRAregulated trustee. An APRA-regulated
trustee can only acquire an investmentlinked life insurance policy in accordancewith the trustee’s own duties in relation
to investment, and would not acquire apolicy that is not consistent with thoseduties. Therefore, in designing theinvestment strategies for investmentlinked policies, a Life Insurer would needto take into account the constraints on
APRA-regulated trustees (discussed in thecommentary on superannuation funds).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

173

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3.

ASSET OWNERS’ USE OF THEIR POSITION TO STEWARD FOR IFSI

3.1

The following section considers theextent to which, and on what basis, eachtype of Asset Owner is (a) required or (b)permitted or able to use its position to
influence enterprises in which it invests
by engaging in stewardship activities
designed to achieve positive sustainability
outcomes and minimise negative
sustainability outcomes.

3.1.1

3.1.2

3.1.3

174

Cooperation and association: Oneconsideration for Asset Owners engaging
in stewardship activities will be whether
engaging in those stewardship activities
involves cooperating with other investors
in the relevant enterprise. Where thatenterprise is a listed company or an
unlisted company with more than 50
members, that cooperation may cause theAsset Owner and those other investors to
become ‘associates’ for the purposes of
the Corporations Act, which may trigger
substantial shareholder and takeoverprovisions under the Corporations Act.
Under Chapter 6 of the Corporations Act,
investors holding more than 5% of a listedcompanies equities are required to lodgea ‘substantial holder notice’. Where ashareholder and their defined ‘associates’in aggregate hold more than 20% of alisted company’s equities they are barredfrom acquiring further securities by
the takeover prohibition of s 606 of the
Corporations Act.
Activities that could result in investors
being considered to be associates include:• investors formulating joint proposals

ACKNOWLEDGEMENTS

3.1.4

relating to board appointments or a
strategic issue;• investors accepting an inducement to vote;• investors agreeing on a plan or strategy

concerning voting;• investors limiting their freedom to vote by

granting another investor an irrevocableproxy; and• investors using their cumulative voting

power to lodge a notice of meeting for the
purpose of putting forward a resolution
relating to the entity’s affairs or thecomposition of the board.
Generally, these activities all involvethe ingredients of (1) an understanding
existing among investors, (2) a course ofaction relating to control of the listed
portfolio constituent’s affairs.
The rules contained in Chapter 6 createa risk for investors with significant
shareholdings seeking to undertake
cooperative stewardship activities.
Where the ‘cooperation’ is limited
to consultative activities such asrecommending that another investor votein a particular manner or exchanging
views on a resolution to be voted on ata meeting, the investors involved will
unlikely be considered ‘associates’.
Investors may make representations to theboard in relation to forward-looking or
long-term strategic matters however theymust avoid making anything that could beconsidered a ‘joint proposal’.

3.1.5

Notwithstanding the foregoing, there
is an acknowledgment from Australia’s
financial regulators of the value of certain
cooperative stewardship activity. In
ASIC’s Regulatory Guide 128: Collective
Action by Investors (June 2015) ASIC
stated that ‘we recognise that investors
should be allowed to cooperate andcoordinate their actions concerning an
entity in which they have invested, in
the interests of promoting long-termvalue for all investors. At times, ‘thistype of engagement can be more effective
and efficient than individual investor
engagement.’136 In this guidance, ASIC
indicated it is less likely to examine
collective action that relates to an entity’s
corporate governance, or issues that canbe determined at a general meeting. ASIC
cited improved sustainability or corporatesocial responsibility reporting as conductthat may not attract its scrutiny.137
Australian industry associations appear
to encourage some form of cooperation
between Asset Owners and Investment
Managers in relation to stewardship.
For instance, the Australian Council
for Superannuation Investors (ACSI)
Stewardship Code (2018), to which
many Asset Owners are signatories,
requires signatories to publicly reporton stewardship activities – such as
collaborative engagement practices.138
The Financial Services Council’s (FSC)Standard 23: Principles of Internal Governanceand Asset Stewardship requires its
Investment Manager members to engage

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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in stewardship on behalf their clientsto ensure that they meet the ‘highest
standard of governance, as well as ethicaland professional practice’. Relevantly,
members must disclose their approachto stewardship activities, including their‘approach to considering Environmental, Socialand Governance factors (risks and opportunities)
and whether these considerations influence
investment decision-making and company
engagement’.139 Despite this industry
push on stewardship, such cooperation
is limited by the factors discussed atparagraphs 3.1.1 to 3.1.3.
3.2

Pension funds

Legal requirements to steward for IFSI
3.2.1

175

An APRA-regulated trustee is not required
to take action where there is unlikely
to be an adverse effect on investment
returns. Similarly, they are not required
to undertake engagement activities
in relation to portfolio constituents
designed to achieve positive and/or
reduce negative Sustainability Impact(whether for instrumental or ultimate
ends investing) instead of or in addition totheir contribution to investment return.
The APRA-regulated trustee may have an
obligation to monitor and manage any
adverse effect on investment returns that
may arise from a negative Sustainability
Impact (and possibly also from failing toachieve a positive Sustainability Impactthat is expected for that business) but
undertaking engagement activities
is not a required response (they may
alternatively, for example, divest theportfolio constituent).

Legal freedom to steward for IFSI
3.2.2

Engagement for Sustainability Impact isundertaken in the course of managing
a superannuation fund’s investment ina corporation, and therefore must also
be consistent with the APRA-regulated
trustee’s duties and other statutory
obligations. Anecdotally, APRA-regulated
trustees routinely engage with theirinvestee companies:

In these cases, it is conceivable that the
APRA-regulated trustee could set anultimate ends IFSI goal that reflects current
and potential members’ desires to achievecertain sustainability outcomes (provided
that the implementation of that goal was
otherwise in compliance with the duties of
the APRA-regulated trustee).
3.2.3(a) for the purpose of protecting or improving
the value of the superannuation fund’sinvestment in the corporation. Where
the trustee forms the view that the valueof the investment may be threatenedby negative Sustainability Impacts or
improved by positive Sustainability
Impacts attributed to the business of thecorporation (over the short, medium orlong term), the stewardship activities
may constitute instrumental IFSI aimed
at reducing the risk of that threat or
promoting those improvements. This isparticularly so where improvements will
also drive financial returns; or(b) to support the APRA-regulated trustee’s
member engagement strategies (aimed at
attraction and retention of members toensure the long term viability of the fund);for example where the corporation’s activities
may have negative Sustainability Impacts
that draw adverse publicity. APRA-regulated
trustees position themselves as being ‘socially
responsible’ or ‘good corporate citizens’ aspart of their member attraction and retention
strategies (even where such engagement
activities are not expected to contributedirectly to investment return).140

3.2.4

In reality, the extent to which APRAregulated trustees undertake thisengagement generally depends on thecosts and benefits to the superannuation
fund of the engagement compared toother options for managing the concern(such as disposing of the portfolio
constituent). Factors such as fund size,
cost of engagement and likelihood ofgetting a hearing, and the possibilityof acting together with other investors
to pursue a common engagement
strategy, will be relevant to the cost /benefit analysis. For example, in 2016,
Australia’s largest superannuation fund,
AustralianSuper, instituted a policy ofvoting against the next director up for
re-election in ASX 200 companies with nofemale directors. In September 2019, it
announced that it would vote against theelection of the most senior director up for
re-appointment if the company has fewer
than two women on the board.141
An APRA-regulated trustee’s statutory
duties to comply with the sole purpose
test, to exercise powers in the bestinterests of beneficiaries and to promote
the financial interests of beneficiaries
make it difficult to undertake
engagement activities in relation to
portfolio constituents by reference to

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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their Sustainability Impact separatelyfrom any potential investment benefit,
as those duties ultimately require an
APRA-regulated Trustee to prioritise
beneficiaries’ financial returns. An
APRA-regulated Trustee would generally
undertake engagement activities where
this was for the purpose of protecting
or enhancing the investment; however,member engagement considerations canalso be important to the ongoing viabilityof a superannuation fund.
3.2.5

176

Academic and practitioner commentaryon how the statutory duties and caselaw are interpreted, in relation to IFSI, isgenerally supportive of an analysis thatthe statutory duties and case law do notpreclude an APRA regulated trustee frompursuing aspects of IFSI where this isconsistent with advancing the financial
interests of the members. Some more
recent commentary proposes that properrisk management and consideration oflong term returns may import an active
obligation for APRA regulated trustees
to consider how negative Sustainability
Impacts may impact investment
performance, on the basis that failure
to do so may result in financial losses tothe fund or not meeting the Investment
objectives. Some of this commentary also
notes that the duty of care and skill is ahigher standard than that required under
the law of trusts.142

3.3

Mutual funds

Sustainability Impacts instead of theircontribution to investment return. The
terms of and the disclosures made by
the scheme may also limit the abilityof the responsible entity to engage for
Sustainability Impact. Notwithstanding
this, it may be possible for a responsible
entity to engage in stewardship activities
in relation to portfolio constituents
designed to achieve positive and/or reduce
negative Sustainability Impacts if thosestewardship activities are reasonably
expected to contribute positively anddirectly or indirectly to the growthin value of the applicable portfolio
constituent. Where stewardship activities
entail minimal expense and effort, it will
be easier for the responsible entity tojustify these activities.

Registered Managed Investment Schemes
Legal requirements to steward for IFSI
3.3.1

We do not consider that responsible
entities are generally subject to a duty toengage for Sustainability Impact, whether
instrumental or ultimate ends IFSI.

3.3.2

However, responsible entities may, inorder to discharge their duty of care anddiligence, be required to have regard
Sustainability Impacts that present
foreseeable risks of harm to the value ofthe portfolio of the scheme and members’interests (which in most cases will likely
equate to the financial interests ofmembers as members) and consider andtake the steps a reasonable responsible
entity would take in the circumstances
to alleviate these risks. Those steps
could conceivably involve engaging in
stewardship with respect to investmentsof the portfolio. Whether a responsible
entity would in fact have a duty to do
so will very much depend on what areasonable responsible entity would do in
the circumstances.
Where a scheme is established with theobjective purpose to generate financial
returns, the responsible entity will likely
be required to act in the best ‘financial’interests of members in engaging in
stewardship activities. This is likely toprevent the responsible entity fromengaging in stewardship activities inrelation to portfolio constituents designed
to achieve positive and/or reduce negative

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Listed Investment Companies

Australia

Legal requirements to steward for IFSI

Brazil3.3.4

Legal freedom to steward for IFSI
3.3.3

ACKNOWLEDGEMENTS

The analysis with respect to schemes atparagraphs 3.3.1 to 3.3.3 above applies
broadly to directors of LICs. Consequently,
we do not consider that LICs are under ageneral legal duty to engage in activities
for Sustainability Impact, whether
instrumental or ultimate ends IFSI (outsideof considering negative Sustainability
Impacts and possible alleviating actions,which may include certain stewardship
activities, where Sustainability Impacts
may have an adverse effect on the value ofthe LIC’s portfolio).

CanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

Legal freedom to steward for IFSI
3.3.5

Though the analysis at paragraph 3.3.3
above in relation to responsible entities
applies broadly to LICs, LICs may have

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3.3.6

3.3.7

a greater legal flexibility to engage in
stewardship activities for
Sustainability Impact.

3.4

In our view, for the reasons set out
at paragraph 2.3.22 relating to thebest interest duty and Investing for
Sustainability Impact, there may be
flexibility within the law for directorsof LICs to engage in stewardship for
Sustainability Impact. That flexibility will
be subject to terms of the constituent
and disclosure documents of the LICs andwill need to be consistent with the bestinterests of the LIC (taking into accountits likely profit-making objective). We
consider that the potential benefit of the
stewardship activity for the interests of
the LIC, the probability of this benefit
arising, and the costs and risk associatedwith the stewardship will be the core
considerations by reference to which
directors must justify their decision to
engage in stewardship activities.

3.4.1

We also note that under the ASX
Corporate Governance Councils Principles
and Recommendations, listed entities(including listed registered managed
investment schemes) should disclose
how they manage or intend to managesocial, environmental and governancerisks.143 Though this does not create alegal obligation on the LIC to engage in
stewardship activities for Sustainability
Impact, it may encourage them to do so.

Insurance undertakingsof or in addition to their contribution toinvestment return. They are not required
to take action where there is no adverse
effect on investment returns.

General insurance: Legal requirements to steward
for IFSI
Investments made by General Insurer
are generally to that support risk policies
or investments of shareholders’ funds.
Therefore, the obligations for insurancecompanies to engage for Sustainability
Impact are as for any other company.144

Life insurance: Legal freedom to steward for IFSI
3.4.5

General insurance: Legal freedom to steward for IFSI
3.4.2

A General Insurer’s investment-related
duties would not prevent an insurancecompany from engaging with portfolio
constituents by reference to their
Sustainability Impact (separately fromany potential investment benefit),provided there was no adverse impact onfinancial returns.

Life insurance: Legal requirements to steward for IFSI
3.4.3

3.4.4

For investments that support risk policies
or investments of shareholders’ funds, theobligations for life insurance companies toengage for Sustainability Impact are as forany other company.145
Investment-linked policies of Life Insurers
are for the purpose of generating financial
returns, and the Life Insurer is required
to prioritise the interests of policy holders
and to comply with the terms of thepolicy. The effect on engagement activities
is that the Life Insurer has no express legal
duty to undertake engagement activities
in relation to portfolio constituents
designed to achieve positive and/or reduce
negative Sustainability Impact instead

3.4.6

Generally, a Life Insurer is permitted toengage with portfolio constituents toachieve positive and/or reduce negative
Sustainability Impact in addition to theircontribution to investment return. There
are no relevant duties that would prevent
them from undertaking these engagement
activities. Engagement activities in relation
to investments held in the statutory funds
will be subject to the duties describedin 2.4.7 to 2.4.11 above. Engagement
activities in relation to investments heldin shareholder funds will be subject tothe general company director’s duties
described in 3.3.4 to 3.3.5.
A Life Insurer could only seek to use
its position as an investor to influence
the activities of an issuer, in relation
to Sustainability Impact, where theoutcome sought was not inconsistent
with promoting financial returns fromthe portfolio (including minimisingrisks). To this extent, an insurancecompany’s investment-related duties
could make it difficult to engage withportfolio constituents by reference to their
Sustainability Impact separately from any
potential investment benefit and if thecost of doing so negatively impacted riskadjusted returns.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

177

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4.

ASSET OWNERS’ ENGAGEMENT IN PUBLIC POLICY WORK TO SECURE SUSTAINABILITY IMPACT

4.1

The following section considers theextent to which, and on what basis, eachtype of Asset Owner is (a) required or (b)permitted or able to use its position to
engage in public policy work designed toachieve positive sustainability outcomesand minimise negative sustainability
outcomes, for example, where these are
relevant to the value of portfolio assets.

4.2

Pension funds

4.2.1

An APRA-regulated trustee is not required
to engage in policy discussions orlobbying with policy makers in relation
to portfolio constituents designed toachieve positive and/or reduce negative
Sustainability Impacts.

4.2.2

4.2.3

There is a level of public debate about theextent to which APRA-regulated trustees
engaging in policy discussions or lobbying
with policy makers, in relation to mattersrelated to Investing for Sustainability
Impacts, is consistent with their legal
duties – in particular, the sole purpose test
and the best interests duty.

fund’s financial returns, including
minimising risks.146 For example, theAPRA-regulated trustee’s assessment may
be that the Government’s policy position(or lack of a policy position) is adversely

and best interests duty in relation to these
activities. As a result, APRA-regulated
trustees may avoid engagement in policy
discussions and lobbying in relation to
Sustainability Impact issues, in order toavoid criticism.
4.2.6• supports the APRA-regulated trustee’s

member engagement strategies (aimed at
attraction and retention of members toensure the long term viability of the fund),for example, where the lobbying or policy
discussion assists the APRA-regulated
trustee in positioning themselves as being‘socially responsible’ or ‘good corporate
citizens’ as part of their member
attraction and retention strategies.
This kind of policy engagement could
potentially be aligned with ultimate ends
IFSI goals discussed in paragraph 3.2.2.
4.2.4

An APRA-regulated trustee could
legitimately consider that engaging
in policy discussions or lobbying with
policy makers is consistent with the sole
purpose test and the best interests duty,
where the engagement:• is aimed at promoting the superannuation

178

impacting, or is likely to adversely
impact, returns of the superannuation
fund, or returns of asset sectors that the
APRA-regulated trustee invests in (orwould invest in). This work may be overthe investment time frames, or in somecircumstances have a longer view; and / or

4.2.5

The debate on the issue of engagement
was seen in the reporting in relation to theopen letter to governments of the world
released in June 2019 that was signed bya number of APRA-regulated trustees.
This has been subject to some criticism
as a political campaign that is not in themembers’ best interests, and the extent towhich active participation in lobbying is
consistent with the best interests test has
also been the subject of comment.147
The current public debate about theappropriateness of APRA-regulated
trustees engaging in lobbying and policy
discussions in relation to climate changerisks has resulted in some uncertainty as
to the operation of the sole purpose test

4.3

As discussed above, APRA-regulated
trustees will be prevented from engaging
in policy discussions and lobbying of thesort described above to the extent thatsuch engagement and lobbying is not in
the best financial interests of members
and consistent with the sole purpose test.
Mutual funds

Registered Managed Investment Schemes
4.3.1

4.3.2

We do not consider that there is a duty
requiring a responsible entity to engage inpublic policy work, policy discussions orlobbying in its capacity as a
responsible entity.
As with stewardship activities, in order fora responsible entity to engage in public
policy work with respect to Sustainability
Impact, the particular policy activity will
likely need to be justified by reference
to financial return to the members of
the scheme. Where public policy workseeking to secure sustainability impact
may be reasonably expected to contribute
positively to the growth in value of
portfolio constituents and is not expected
to cause a decline in the short-termvalue of these businesses, this policy
discussion and/or lobbying may be open toa responsible entity.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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4.3.3

Before commencing public policy work,
responsible entities are required, under
their duty of care and diligence toconsider and evaluate the costs, benefits,potential risks and the likelihood of
potential positive and negative outcomesto the members of the scheme.

funds, the considerations for insurancecompanies in relation to engaging inpolicy discussions are as for any othercompany. (See commentary on directors’
duties to shareholders and the company
generally at paragraphs 1.3.12 to 1.3.17
and specifically in relation to policy
engagement at 2.4.8 to 2.4.11.)

Listed Investment Companies
4.3.4

The analysis with respect to stewardship
activities of LICs, described at 3.3.4 to
3.3.7, largely applies to public policy workof LICs. As such, we do not consider LICs
to be subject to a duty to conduct public
policy work for Sustainability Impact,
and the ability of a LIC to engage inpublic policy work will be limited by theconstituent and disclosure documentsof the LIC and by reference to the likely(predominantly, but not exclusively,financial) benefits of that public policy
work to the LIC.

4.4

Insurance undertakings

4.4.1

An insurance company is not required toengage in policy discussions or lobbying
with policy makers in relation to portfolio
constituents designed to achieve positive
and/or reduce negative Sustainability
Impacts. In practice, it is unusual for
insurance companies to engage in policy
discussions or lobbying with policy
makers. Insurance companies are, inmany cases, owned by listed companies(in Australia and overseas) and any policy
discussions or lobbying would be inaccordance with the group’s positioning
on the relevant issues.

4.4.2

179

For investments that support risk
policies or investments of shareholders’

4.4.3

Investment-linked policies of Life Insurers
are for the purpose of generating financial
returns, and the Life Insurer is required
to prioritise the interests of policy holders
and to comply with the terms of thepolicy. The effect on participation inpolicy discussions is that, in principle, aLife Insurer would be permitted to engage,
and would not be restricted or prevented
from engaging, in policy discussions andlobbying with policy makers, in relation to
portfolio constituents designed to achieve
positive and/or reduce Sustainability
Impacts, provided the outcome sought
was not inconsistent with:• promoting financial returns from theinsurance company’s investment portfolio(including minimising risks); or

4.4.4

example, policy discussions and lobbying in
relation to carbon reduction and measures
to be taken to reduce the pace of climatechange may be justifiable on the basisthat the expected consequences of climatechange (including the possible increased
frequency of extreme and destructive
weather events) may negatively affect theinsurance company’s insurance business(through a greater and more unpredictable
rate and quantum of claims).
4.4.5

Whether or not public policy work
would be considered inconsistent withpromoting financial returns of theportfolio if it risked short-term detrimentto financial returns for better returns in
the long term would largely depend upon
the strategy for the particular investment
in question. For example, it is possiblethat an insurer, in compliance with all
its statutory obligations and duties could
place a portion of its portfolio into an
investment with a long term strategy
of using public policy engagement toimprove returns.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union• for Life Insurers in relation to investment-

Francelinked policies, the objectives governed by
the terms of the policy and any disclosure
documents issued to investors.

Japan

We note that there may be policy
discussions and lobbying engagementof the sort described above that can bejustified on that the outcomes sought
are likely to contribute positively tothe financial interests of the insurancecompany [beyond financial materiality
to its current investment portfolio]. For

South Africa

Netherlands

United Kingdom
United States

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AUSTRALIACONTENTSFOREWORDSINTRODUCTION

5.

ESTABLISHING NEW FUNDS TO INVEST FOR SUSTAINABILITY IMPACT AND AMENDING THE
TERMS OF EXISTING ONES

5.1

The following section considers the extent
to which it is possible for an Asset Owner
to set up a fund, policy or other productwith the express objective of IFSI.

5.2

Pension funds

5.2.1

An APRA-regulated trustee is permitted
to set up a superannuation fund,or an investment option within asuperannuation fund, that Invests for
Sustainability Impact as well as financial
return, in which beneficiaries can choose
to invest.

5.2.2

5.2.3

5.2.4

5.2.5

180

As discussed in paragraphs 2.2.30 to
2.2.32, an APRA regulated trustee’s
statutory duties remain paramount at all
times. It is therefore at best uncertain as
to whether a fund or investment option
could be offered where IFSI takes priority
to financial return.
An APRA-regulated trustee may include
considerations of IFSI in formulating
investment strategies, where doing so
is consistent with generating financial
returns (which may be long term returns)
and managing risk (see paragraph 2.2.33)
and section 9.

prioritise Investing for Sustainability
Impact that this would be done. It isdifficult to see how a trustee could
determine that it is in the best interestsof members to make a decision to change
an option that beneficiaries had invested
into, knowing that it prioritised financial
returns, into an option that insteadprioritised Sustainable Impact. To do sowould also be an adverse significant event,and require notice to all members.
Duties on those designing, manufacturing andproviding pensions
5.2.6

5.2.7

Additionally, proper formulation of
investment strategies may necessarily
require consideration of Sustainability
Impact risks (see previous commentary atparagraph 2.2.37).148
It is highly unlikely that even if itwere possible for a choice product orinvestment option to be changed to

5.2.8

From April 2021 APRA-regulated
trustees will be required to comply withnew product design and distribution
obligations.149 These obligations include therequirement to make a publicly available‘target market determination’ in relation
to choice superannuation products that canbe acquired by retail clients.
While ASIC is yet to issue final guidancein relation to its interpretation of theseobligations, it has stated that it expects
issuers and distributors to introduce andmaintain effective governance processes
across the lifecycle of financial products,
such that the target market determination
for a product might change over time if
data shows that the consumers who are
actually buying the product are different
to the original target market.150
These new requirements will oblige
product issuers to gather information
about the consumers purchasing theirproducts, which could potentially create an
opportunity to get more insight into why
consumers have purchased a particular
product, and the relevance of Investing for
Sustainability Impact in their decision.
5.2.9

As described in paragraph 2.2.23 there
are also statutory disclosure obligations
with which an APRA-Regulated Trustee
is required to comply for any product orinvestment option.

5.3

Mutual funds

Establishing a new retail investment fund for
Sustainability Impact investing
5.3.1

5.3.2

5.3.3

Registered managed investment schemes
may be set up with an express objective
to Invest for Sustainability Impact as wellas, or having priority over, a financial
return, provided that the scheme isintended to produce financial benefits, or
benefits consisting of rights or interests inproperty. If it is not intended to produce
those benefits, the scheme would notsatisfy the elements of the definition of‘managed investment scheme’ under the
Corporations Act.
Listed investment companies can be set
up with an express objective to Invest for
Sustainability Impact either as well as, or
having priority over, a financial return inwhich investors can choose to invest, or
have their benefits determined against.
In all cases, the ability of a fund or othervehicle to Invest for Sustainability Impact
either as well as, or having priority over,

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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AUSTRALIACONTENTSFOREWORDSINTRODUCTION

financial return would need to be clearly
expressed as a purpose of the fund orother vehicle and permitted within theinvestment strategy and investment
guidelines of the scheme in theconstitution of the fund (or other vehicle)
and the product disclosure statement orother applicable disclosure document of
the fund (or other vehicle).
5.3.4

5.3.5

With regard to articulating investing forsustainability impacts effectively as the
purpose responsible entities may wish tohave their scheme’s investment strategy
certified by the Responsible Investment
Association of Australasia (RIAA) under
the RIAA’s Constitution and Strategy(RIAA Standards). This requires that
Asset Owners assist in achieving the
RIAA’s stated belief that ‘investment andownership practices can and should alignwith society’s needs and objectives, suchas those set out in the ‘UN’s Sustainability
Development Goals’. The Asset Owneris then required to follow a number ofcommitments that align with this belief.
Alternatively, a responsible entity may
wish to be certified under the RIAA’smore rigorous Responsible Investments
Certification Program (RI Certified).
Certification under this program entails
subscribing to a detailed program ofstandards and a code of conduct.

Amending the terms of a retail investment fundto reflect a commitment to Sustainability impact
investing
5.3.6

181

Under the Corporations Act, anamendment of the constituent documents
would likely be required to permit ascheme or a LIC to have an express
objective to Invest for Sustainability
Impact, and this would require theapproval of members by special resolution(being a resolution passed with at least
75% of votes cast by members entitled tovote on the resolution).151
5.4

Life insurance products

5.4.1

Whether or not it is permissible for a
Relevant Investor to set up a fund or othervehicle that Invests for Sustainability
Impact either as well as, or having priority
over, financial return is not applicable
to Life Insurers in relation to their risk
policies, as policy holders have the right topayment of specified amounts in specified
circumstances (ie investment returns do
not impact their rights). The question is
however relevant to the investment-linked
business of Life Insurers. (See commentaryon directors’ duties to shareholders andthe company at paragraphs 1.3.12 to1.3.17.)5.4.2

For the superannuation business of Life
Insurers, the policy holder is the APRAregulated trustee. An APRA-regulated
trustee can only acquire an investmentlinked life insurance policy in accordancewith the trustee’s own duties in relation
to investment, and would not acquire apolicy that is not consistent with thoseduties. Therefore, in designing theinvestment strategies for investmentlinked policies, a Life Insurer would needto take into account the constraints on
APRA-regulated trustees (discussed in thecommentary on superannuation funds).

5.4.3

For investment-linked nonsuperannuation policies, the Life Insurer
can offer investment portfolios on any
basis determined by the Life Insurer.
The portfolios supporting these policies
could therefore be constructed to include
Investing for Sustainability considerations,and the terms of the policies anddisclosure documents may be drafted toinclude Investing for Sustainability Impact
objectives. As the Life Insurer’s obligation
is to comply with the terms of the policy,
as contractual obligations, there is no
obstacle to designing and offering aportfolio that prioritises Investing for
Sustainability Impact over financial
returns. Once the policy has been started,
it could only be amended to include
provisions for IFSI if both parties to thecontract agreed to the amendment.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

Duties on those designing, manufacturing andproviding life insurance

Brazil5.4.4

The information on new design anddistribution obligations for productissuers in 5.2.6 to 5.2.8 is also relevant forlife insurers.

CanadaLife Insurers must also ensure thatlife insurance policies are designedin accordance with the ‘Policy designand disclosure’ requirements of theLife Insurance Code of Practice. Theseobligations include that the Life Insurer
will define suitable customers for the
product, regularly review on sale products
to ensure they remain generally suitable
for the relevant customers, and re-design
on-sale products where necessary.152

France

5.4.5

China

European UnionJapan

Netherlands

South Africa
United Kingdom
United States

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6.

INVESTMENT MANAGERS’ DUTIES TO INVEST FOR SUSTAINABILITY IMPACT

6.1

This section considers the extent to which,and in what circumstances, an Investment
Manager is (a) required or (b) permitted toInvest for Sustainability Impact on behalf ofan Asset Owner or otherwise, in each of thethree ways contemplated in sections 2-4.

6.1.1

6.1.2

(iv) a clause that allows APRA accessto documentation and information
related to outsourcing arrangement,
including the right for APRA to
conduct on-site visits to theservice provider.

In this Annex the Investment Managers
considered are the Investment
Managers who manage funds on behalfof superannuation funds, insurancecompanies and registered managed
investment schemes. We have notconsidered Investment Managers of LICs
as we have only considered internallymanaged LICs in our analysis.
Australian Investment Managers’
investment duties and powers derive from:(a) the terms of the investment managementagreement (or another similar agreement)with the relevant Asset Owner (IMA).
An IMA entered into between an APRAregulated trustee of a superannuation
fund or an insurance company isrequired to include certain prescribed
content, including:(i)

service levels and performancerequirements, form of keeping data,
ownership and control of data,reporting requirements (including
content and frequency of reporting);(ii) liability and indemnity andoffshoring arrangements;(iii) an indemnity to the effect that any
sub-contracting of the outsourced
function will be the responsibility ofthe service provider (the Investment

182

Manager), including liability for
any failure on the part of the subcontractor; andThere is no prescribed content for IMAs
between Investment Managers andresponsible entities and LICs. Some
industry templates produced by the FSC
and ACSI are widely used as the basis for
IMAs for responsible entities and LICs.153

engage in IFSI, the Investment Manager
will be bound by the relevant terms
to pursue a sustainable investment
strategy. This must be balanced with
the Investment Managers interests ingenerating financial returns so as to avoid
breach of their duties.
6.1.4

If the IMA does not include Sustainability
Impacts within its investment objectives,
we do not consider that the Investment
Manager is under any legal obligation to
do so.

6.1.5

If an Asset Owner sought to require its
Investment Manager to incorporate IFSI
into the Investment Managers investment
mandate, the terms of the IMA must be
amended to provide for this.

(b) certain statutory obligations that apply to
all AFS Licence holders;154

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS(c) the duty of care owned to Asset Owners
in tort. This duty can be modified and/or excluded in an IMA between an
Investment Manager and a managed
investment scheme, but not in an IMA
between an Investment Manager and an
APRA-regulated trustee;155

Engagement to achieve Sustainability Impact

Australia

6.1.6

As above, unless specifically set out in the
IMA, we do not consider that there is any
duty on an Investment Manager to engage with portfolio companies (orany other stakeholders) to achieve
Sustainability Impacts.

Brazil(d) fiduciary duties owed to Asset Owners(which can be modified or contracted out
in the IMAs terms);156 and6.1.7

Notwithstanding that, it is possible thatnegative Sustainability Impacts may
have an adverse effect on the value ofthe portfolio constituents over the time
horizons that apply under the IMA, andto the extent that they do, an Investment
Manager may be required, pursuant toits duty of care, to consider what steps areasonable Investment Manager would
take in the circumstances, having regard
to the magnitude of the risk and thedegree of the probability of its occurrence,France(e) the duty to exercise reasonable care andskill to the Asset Owner pursuant to an
implied term of the IMA, or by virtue ofbeing a professional.157
Legal obligations with respect to Sustainability Impact
Powers of investment and divestment
6.1.3

If the IMA or other such document
requires the Investment Manager to

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along with the expense, difficulty andinconvenience of taking alleviating action
and any other conflicting responsibilities
which the Investment Manager may, andtake those steps (which may or may not
involve stewardship activities).

could be easily given (with a waiver oramendment of the IMA) or denied.
Engagement to achieve Sustainability Impact
6.2.3

Public policy work to achieve Sustainability Impact
6.1.8

6.2

Again, unless the Investment Managers’
mandate includes public policy workto achieve a Sustainability Impact as an
objective, we do not consider there to be
any legal obligation for an Investment
Manager to do so.

6.2.4

Legal freedom to Invest for
Sustainability Impact

Powers of investment and divestment
6.2.1

6.2.2

183

Where an IMA is silent on Investingfor Sustainability Impact, given theInvestment Manager’s duties and thelikely financial return objectives under the
IMA, Investment Managers are likely to beunable to exercise its investment powers
to Invest for Sustainability Impact unlesssuch exercise is otherwise consistent with
the IMA and the relevant investment
or divestment could be justified on
purely financial grounds (which we
acknowledge could conceivably encompass
instrumental and ultimate ends IFSI).
Investment Managers may be reluctant
to exercise their investments powers to
Invest for Sustainability Impact as theirremuneration is often tied to the valueof portfolio being managed and they may
also be unwilling to pursue additional
objectives without the express approvalof the Asset Owner, where that approval

In the absence of express authority
under the IMA, an Investment Manager
is unlikely to be permitted to engage
in stewardship activities in relation to
portfolio constituents designed to achieve
Sustainability Impacts instead of theircontribution to investment return.
It may however be possible for an
Investment Manager to engage in
stewardship activities in relation to
portfolio constituents designed to reduce
negative Sustainability Impacts if thosestewardship activities are reasonably
expected to contribute positively anddirectly or indirectly to the growth in valueof the applicable portfolio constituent.

6.2.5

Public policy work to achieve Sustainability
Impact6.2.6

Investment Managers are free to engage inpublic policy work if funded from its own
resources provided it is in the Investment
Manager’s company’s best interest anddoes not create a conflict between theInvestment Manager and its clients.

6.2.7

If an Investment Manager undertakes
public policy work on behalf of an Asset
Owner, it must do so in accordance withthe terms of the IMA and without creating
any conflicts of interest with its client. In
practice an Investment Manager will likely
only undertake such work where it has
express authority to do so under the termsof the IMA.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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7.

LEGAL LIABILITY TO THIRD PARTIES FOR THE NEGATIVE SUSTAINABILITY IMPACT OF
ENTERPRISES IN WHICH PORTFOLIOS ARE INVESTED

7.1

This section considers the extent to which,regardless of the legal rules under which itis required to operate and its constitution,
an Asset Owner could be legally liable tothird parties for the negative Sustainability
Impact of enterprises in which it invests,
and whether an Investment Manager could
also be liable because of its role in assisting
the Asset Owner to invest in the relevant
enterprise and steward its investment.

7.2

Asset Owners

7.2.1

Asset Owners may face civil liability under
the tort of negligence. It is unlikely that
Asset Owners will face criminal liability
for the negative Sustainability Impacts ofthe businesses or asset that they fund.

in Australia are typically not held liable
for the acts of their subsidiary companies.
Australian Courts have, however, , on a
few limited occasions established liability
in the tort of negligence pursuant toa duty of care owed by a controllingparent entity to employees of, and third
parties dealing with, subsidiaries.160 The
decisions turned broadly on the questionsof whether the parent company exerted
a sufficient degree of control or influence
over its subsidiary company and whether
the harm to the claimant was reasonably
foreseeable.161 This line of cases may belimited to where a parent company exerts
control or influence over its subsidiarycompany and we have not identified any
decisions in Australia where the courts
have applied the reasoning in this line ofcases and extended the duty of care beyond
the parent company-subsidiary relationshipto institutional or other financial investors(ie Asset Owners in a shareholder ormanagement capacity).

Civil liability
7.2.2

7.2.3

184

As the law presently stands in Australia,
there is no general duty to take steps tomitigate negative Sustainability Impacts.158
As such, the most relevant cause of action
to be brought against an Asset Ownerin these circumstances is negligence.
Subject to the limited circumstances
described in paragraph 7.2.3, it is unlikelythat an Asset Owner would owe third
parties a duty of care to take reasonablecare to refrain from contributing tonegative Sustainability Impacts, incircumstances where the Asset Owner
owes an inconsistent legal duty to act in
the best (and, likely, financial) interests ofbeneficiaries.159
As a consequence of the doctrine ofseparate legal personality, parent companies

Criminal liability
7.2.4

7.2.5

It is unlikely that an Asset Owner could
be held criminally liable for negative
Sustainability Impacts of enterprises
they have funded. The nature of therelationship between Asset Owners andinvestee companies make establishing any
cause of action highly unlikely (without
developments in Australian criminal law).
If Asset Owners were appointed as nominee
directors of investee companies, and had

managerial responsibility in relation to thecausation of a negative Sustainability Impact(eg, destruction of a cultural site, pollutionof a national park, breach of environmentallaws) criminal liability could possibly arise.
However, that liability may attach only to thenominee directors personally, rather than to
the Asset Owner who appointed them.
Reputational, regulatory and other risks
7.2.6

We also note that, as in other jurisdictions,
NGOs are increasingly making complaints
to Australia’s National Contact Point (NCP)
alleging breaches of the OECD’s Guidelines.
Though complaints have not yet been
made against relevant Asset Owners,162 theAustralian NCP is currently considering amatter involving a banks financing of anentity linked to forcible evictions and humanrights abuses, and a number of other similar
matters have been brought indicating future
potential for complaints to be made directlyagainst Relevant Investors.163

7.3

Investment Managers

7.3.1

Investment Managers, like Asset Owners,may, in limited circumstances face
civil liability for negative Sustainability
Impacts under the tort of negligence. It is
unlikely that Investment Managers will
be held criminally responsible for thenegative Sustainability Impacts of assets
they have selected for investment.

Civil liability
7.3.2

The analysis concerning civil liability
for Asset Owners of 7.2.2 and 7.2.3

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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United States

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applies equally in the case of Investment
Managers. Investment Managers may, in
limited circumstances, attract liability
under the tort of negligence. We note that
although this analysis applies equally toAsset Owners and Investment Managers, it
is even less likely an Investment Manager
would be found to have civil liability to
third parties for negative Sustainability
Impacts. By virtue of their engagement
through the IMA, the Investment
Managers are further removed from any
conduct which amount to a negative
Sustainability Impact. In addition, theindemnification rights of Investment
Managers under their IMA may shield
Investment Managers from any liability
from any such causes of action.
Criminal liability
7.3.3

It is unlikely that an Investment Manager
could be held criminally liable for negative
Sustainability Impacts of enterprises they
have funded. The analysis with respect tothe relationship between Asset Owners
and investee companies detailed at 7.2.3
applies equally in the case of Investment
Managers. Additionally, comments
related to the potential criminal liabilityof Relevant Investor-appointed nominee
directors at 7.2.4 also apply. In this case,as in the circumstances detailed above,
criminal liability would only attach to thenominee director personally and not theRelevant Investor that appointed them.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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8.

THE GROWING IMPORTANCE OF TAKING ACCOUNT OF ESG AND SUSTAINABILITY FACTORSWHERE THESE ARE ‘FINANCIALLY MATERIAL’

8.1

It has become increasingly importantfor Relevant Investors to take ESG andsustainability factors into account inmanaging portfolios because of the way inwhich they could be material to achieving
the financial investment objectives of
the Relevant Investor in accordance with
their legal duties. The main reasons are
summarised below.

8.1.1

In Australia, there has been growing
awareness of the importance of taking
into account sustainability factors wherethese are financially material. This isevidenced by a catalyst of developments
in Australian policy, law, regulation andindustry best practice focusing on ESG andsustainability issues (primarily climatechange). Key developments include:(a) recognition by APRA in its SPG 530 that
APRA-regulates trustees may, under their
existing duties, offer ethical investment
options and/or integrate ESG considerations
into the formulation of investment strategy
and analysis.164 Earlier this year APRA
indicated it intends to update SPG 530 to‘ensure that the financial risk of climate change ismanaged effectively’ and urged entities to act
prudently to ‘assess and mitigate’ climate
related risks before its updated guidance isreleased.165 APRA also outlined its plans torelease a climate change Prudential Practice
Guide and to develop a climate change
financial risk vulnerability assessment.166
Further, in 2019, APRA commented thatits regulated entities must actively assess

186

climate change risk and incorporate theassessment into governance practices;167(b) enhanced levels of disclosure increasingly
encouraged/required by Australian
regulators. These disclosures appear
in certain entities’ risk management
frameworks, sustainability reports (orother integrated reporting documents), ina director’s operating and financial review,prospectuses and other public investment
strategies.168 ASIC has indicated that it
considers that it may be misleading if
an entity does not include ESG related
disclosures in its operating and financial
review or prospectus,169 and one case wasbrought by the Environmental JusticeAgency alleging the Commonwealth Bank
of Australia should have disclosed climatechange as a material risk in its annual
report (the case was later discontinued).170
This increased focus on ESG disclosures hasin turn has created a changing environment
in which investments are made;(c) an increasing regulatory push on
climate change issues, evidenced by thestatements and documents released byAustralia’s financial regulators, APRA,171
the RBA172 and ASIC,173 which called oncompanies and government to take action
on climate change, further creating achanging regulatory environment underwhich investments are made; and(d) leading industry associations developing(sometimes mandatory) guidance andstandards which includes ESG andsustainability factors. Of particularimportance are the standards andguidance developed by the FSC, ACSI andAASB, which provides for ESG related
issues in voting of their members,174
governance,175 financial reporting andother disclosures,176 and stewardship.177
8.1.2

There is also a growing body ofcommentary suggesting that beneficiaries
may seek to argue that Asset Owners andtheir Investment Managers have breachedtheir duty to act with care and skill,or their duty to act in the best interestof a company, if they fail to consider
financially materially ESG factors.178 We
are not aware of any jurisprudence inAustralia that has yet pronounced on
this cause of action. With the recent caseagainst REST superannuation settling latelast year (see 2.2.27), we will have to wait
some time for these laws to update.

8.2

Financial materiality

8.2.1

Because of the growing importance oftaking account of ESG and sustainability
factors in the investment process where
financially material, it is important tounderstand how the law defines what is‘financially material’ and the period byreference to which financial materiality
must be measured. Taking accountof these factors in order to pursue
financial objectives may incidentally
have Sustainability Impacts and may
also be consistent with Investing for
Sustainability Impact.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

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United Kingdom
United States

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8.2.2

8.2.3

8.2.4

187

The level of significance that is necessary
for an ESG factor to be taken into accountin seeking to secure financial return inthe management of a portfolio, or the‘financial materiality’ of ESG factors,
is not defined in Australian statute or
general law. However, financial materiality
is considered in the context of financial
statement disclosure obligations. Financial
disclosure obligations typically require
disclosure of any financial material risks
and opportunities.
Under the Corporations Act, disclosuremust be made of financially material
information that would have an effect on
the entity’s securities.179 Pursuant to s 677,
information will have a material effect on
the price or value of securities if it ‘would,
or would be likely to, influence persons
who commonly invest in securities in
deciding whether to acquire or dispose of
the … securities.’ The same approach isadopted across several industry standards
on financial reporting. For example,
the Australian Accounting Standards
Board (AASB) — a Commonwealth entity
responsible for developing Australian
Accounting Standards defines materiality
as ‘an entity-specific aspect of relevancebased on the nature or magnitude,
or both, of the items to which theinformation relates in the context of anindividual entity’s financial report.’180
Likewise, the ASX Listing Rules — which
require ASX listed Asset Owners tocontinuously disclose financially material
information — define material (or ‘market
sensitive’) information as the informationthat ‘a reasonable person would expect
to have a material effect on the price orcompany and therefore are most important toinvestors’.185 Through its ‘Materiality Map’,
SASB has identified several sustainability
issues as financially material within arange of industries.186

value of the entity’s securities’.181
8.2.5

Industry is increasingly recognising thatenvironmental, social and governancerisks are financially material. Although
they are non-binding in nature, thefollowing standards show a developing
trend towards recognizing financial
materiality of ESG considerations:
The ASX Corporate Governance Principles
and Recommendations require listedcompanies to disclose ‘material exposure toenvironmental or social risks’.182 While the
Guidance Principles do not define what‘material exposure’ is, at least in respectof climate change risks, reference is madeto the Financial Stability Board’s TCFD, inwhich entities are ‘encourage[d]’ to consider
in assessing their respective material
exposure to climate change risk.183
The ESG Reporting Guide for AustralianCompanies, issued by the FSC (which
represents Investment Managers) and
ACSI (which represents Asset Owners),
states that:184 ‘ESG risks are material,
where a reasonable person would consider the
information to have an impact on a company’svaluation or the sustainability of its operations.
The risk(s) could have an immediate orforeseeable impact on earnings, an impact on abalance sheet, or an impact on the sustainabilityof its operations.’ It is significant that, forfurther guidance on materiality, the ESG
Reporting Guide makes express reference
to the definition of financial materiality
provided by the Sustainability AccountingStandards Board (SASB). SASB defines
financially material issues as ‘the issues thatare reasonably likely to impact the financial
condition or operating performance of a

In December 2018, the AASB issued a newpractice statement regarding financial
materiality of climate-related and otheremerging risks.187 The practice statement
underlines a developing industry
understanding that climate-related risks
can no longer be considered solely from asocial corporate responsibility perspective.
8.3

Time period by reference to which‘materiality’ is to be assessed

8.3.1

As a general rule, materiality would beassessed with reference to the timeframethat is disclosed to beneficiaries in relation
to the particular investment strategy. So,for example, if a strategy was disclosedwith a strategy to return 3% over 7 years,
then materiality would be assessed byreference to the impact over 7 years.

8.3.2

For pension funds, it is also instructive
to look at the statutory obligations
in relation to the development ofinvestment strategies and the way inwhich investment returns are reported,on the assumption that materiality would
be assessed with reference to similar
timeframes. For example:(a) APRA-regulated trustees are required toboth include 10 year investment target
returns in the investment strategy for
MySuper products, and to publish theactual 10 year returns for these products(when they are available, noting that most
MySuper products commenced in 2014), and

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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currently reports investment performancefor MySuper products over 3 and 5 year
periods. This is slated to expand to include
longer time horizons (e.g. 7 and 10 years)
as time progresses.188
8.4

For LICs and registered managed
investment schemes, Relevant Investors
must measure financial materiality
over an appropriate time period whichallows them to meet their general duties
discussed in this report and the periods
disclosed to beneficiaries. However,literature suggests that, as a matter ofinvestment practice, the time period will
to some extent depend on the type ofinvestor that the fund will be marketed
to and investment in question. For
short-term (retail) investors, corporate
strategies which sacrifice an immediate
profit in order to mitigate long-term ESG
risk will be unattractive. Conversely,
for the longer term Relevant Investors,
slow changes in environmental andsocial conditions matter more.189 The
specific duration of the fund, in the caseof a closed-end fund or the tenure ofan Investment Manager will largely be
determined at the outset of the fund’s
creation as opposed to any negotiation
between Asset Owners and investors.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY
Anton Bobenko, Michael Chaaya, William
Chaffey, Kon Mellos, James Whittaker andPhoebe Wynn-PopeA. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

188

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1

Cowan v Scargill [1985] Ch 270.

2

ASIC v Lewski [2018] HCA 63, [71].

3Australian Prudential Regulation Authority v Kelaher [2019] FCA
1521.

4

Thomas G, The duty of trustees to act in the ‘best interests’ of theirbeneficiaries (2008) 2 Journal of Equity 177.

5

Australian Prudential Regulation Authority (APRA) v Kelaher [2019]
FCA 1521, [65].

6

Ibid [49].

7

Ibid.

8

Ibid [55].

9Donald, M Scott and Taylor, Nicholas, Does ‘sustainable’ investing
compromise the obligations owed by superannuation trustees?
(2008) 36 Australian Business Law Review 47, 49, citing Maciejewski
v Telstra Super Pty Ltd [1999] NSWSC 341 [13]; Telstra Super v
Flegeltaub (2000) 2 VR 276; Sayseng v Kellogg Superannuation[2003] NSWSC [63].

10Asea Brown Boveri Superannuation Fund No. 1 Pty Ltd v Asea
Brown Boveri Pty Ltd and Others [1999] 1 VR 144: The Court found[at 65]: ‘… trustees of a superannuation fund owe a duty of loyalty
exclusively to the members. It does not follow from that, however,that a trust deed can never be altered to meet the interest of theemployer. Trustees are free to negotiate with an employer for a
package of amendments that may include benefits to the employer
if in the opinion of the trustees that would benefit the members’.

11Treasury Laws Amendment (Measures for a later sitting) Bill 2020:
Best Financial Interests Duty introducing ‘best financial interest’ andreplacing ‘best interest of the beneficiaries’.

12

Treasury Laws Amendment (Measures for a later sitting) Bill 2020:
Addressing underperformance in superannuation assessing
underperforming funds and freezing new beneficiaries if
underperformance continues for 2 years.

13

14

15

16

17

18

189

Slea Pty Ltd v Connective Services Pty Ltd [2017] VSC 609 [156],
citing Permanent Building Society (in liq) v Wheeler (1994) 11 WAR
187.
Slea Pty Ltd v Connective Services Pty Ltd [2017] VSC 609 [156],
citing Reid Murray Holdings Ltd (in liq) v David Murray Holdings Pty
Ltd (1972) 5 SASR 386.
Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286; applied in
Ngurli Ltd v McCann (1953) 90 CLR 425, 438 (both in the context ofshareholders voting rights). For criticism of the decision’s application
to the best interest duty, see generally, du Plessis, Jean J, ‘Directors’
duty to act in the best interests of the corporation: ‘Hard cases makebad law’ (2019) 34 Aust Jnl of Corp Law 3.
See, eg, Russell Kinsela Pty Ltd (in liq) v Kinsela [1983] 2 NSWLR 452
and Prof Sealy, L S, Bona Fides and Proper Purposes in Corporate
Decisions (1989) 15 Monash University Law Review 265, 265-6. See,also, du Plessis, above n, 17-19.
Bell Group Ltd (in liq) v Westpac Banking Corp (No 9) [2008] WASC
239, [4393] per Owen J, as approved in ASIC v Cassimatis (No 8)(2016) 336 ALR 209, [516] (though in the context of a directors dutyof care, skill and diligence).
Parliamentary Joint Committee on Corporations and Financial
Services, Corporate Responsibility: Managing Risk and Creating

Value (June, 2006), [4.6], [4.8] (PJC Report).

38

Tubemakers of Australia Ltd v Fernandez (1976) 10 ALR 303.

19

See generally, Jean J du Plessis ‘Directors’ duty to act in the bestinterests of the corporation: ‘Hard cases make bad law’ (2019) 34
Australian Journal of Corporate Law 3, 24-6.

39

Re Courage Group’s Pension Schemes [1987] 1 WLR 495.

40

Vatcher v Paul [1915] AC 372.

20Bell Group Ltd (in liq) v Westpac Banking Corp (No 9) [2008] WASC
239, [4393].

41

Cowan v Scargill [1985] Ch 270.

42

Vatcher v Paul [1915] AC 372.

43

M Scott Donald, Jarrod Ormiston and Kylie Charlton ‘The potential
for superannuation funds to make investments with a social impact’(2014) 32 Company and Securities Law Journal 540.

44

Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285.

21PJC Report [4.6].

22

See Bell Group Ltd (in liq) v Westpac Banking Corp (No 9) [2008]
WASC 239; ASIC v Cassimatis (No 8) (2016) 336 ALR 209; Prof Baxt
AO, Bob, ‘Future directions for Corporate Law: Where are we now
and where do we go from here? The dilemmas of the modern
company director’ (2011) 25 Australian Journal of Corporate Law
213; Jean J du Plessis, ‘Directors’ duty to act in the best interests ofthe corporation: “Hard cases make bad law” (2019) 34 Australian
Journal of Corporate Law 3, 23.

23

Angas Law Services Pty Ltd (in liq) v Carabelas [2005] HCA 23(Angas) [67] (Gummow and Hayne JJ).

24

ASIC v Cassimatis (No 8) (2016) 336 ALR 209, As that time ofwriting, there are no reported decisions in which the courts haveenunciated a clear position as Edelman J’s in Cassimatis specificallyin connection with the best interests duty of company directors.
Cassimatis appealed this decision before the full Federal Court
where the appeal was dismissed. See Cassimatis v ASIC (2020) 376
ALR 261.

25

ASIC v Healey [2011] FCA 717, [14], though considering community
interests as an interest which can be affected by directors decision
making broadly and not in the context of the best interest duty.

26

Owen J in Bell Group Ltd (in liq) v Westpac Banking Corp (No 9)[2008] WASC 239 [4394] approving of Heydon JD in ‘Directors’
Duties and the Company’s Interests’ in Finn P, ‘Equity andCommercial Relationships’ (1987).

27

PJC Report, [4.39]; CAMAC, Parliament of Australia, The Social
Responsibility of Corporation, (Report, 12 December 2006) 111.

28

Kenneth Hayne AC QC, ‘Remarks to Business Roundtable on Climate
and Sustainability’ (Centre for Policy Development, 21 November2019) https://cpd.org.au/2019/12/full-text-of-kenneth-hayne-ac-qcremarks-to-cpd-climate-roundtable/.

29

Prof Baxt AO, Bob, ‘Future directions for Corporate Law: Where
are we now and where do we go from here? The dilemmas ofthe modern company director’ (2011) 25 Australian Journal of
Corporate Law 213, 225.

30

Gerald Acquaah-Gaisie, ‘Toward more effective corporate governancemechanisms’ (2005) 18 Australian Journal of Corporate Law 1.

31

Bryan Horrigan, ‘Teaching and integrating recent developments incorporate law, theory and practice’ (2001) 13 Australian Journal of
Corporate Law 182, 23.

32

See 2.2.11, 2.3.11 and 2.3.15.

33

ASIC v Avestra Asset Management Ltd [2017] FCA 497, 559-60(Beach J).

34

Ibid 560.

35

Ibid.

36

Council of the Shire of Wyong v Shirt (1980) 146 CLR 40.

37

Ibid.

45

See, Corporations Act s 181(1)(b).

46

For example, we do not consider the effect of Military
Superannuation and Benefits Act 1991 (Cth) or any other legislation
specific to the superannuation and retirement benefits of membersof the Australian Defence Force, or any legislation in relation to the
Public Sector Superannuation Accumulation Plan.

47

An interdependency relationship is defined in the Superannuation
Industry (Supervision) Regulations 1994 (Cth) at Reg 1.04AAAA as
one which, taking into account all the circumstances, one or eachof the people provide the other with support and care of a type andquality normally provided in a close personal relationship, rather
than by a mere friend or flatmate.

48

Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act) s
52(6)(a).

49

Trusts Act 1973 (Qld), Part 3 (sections 21 — 30C); Trustee Act 1925
(NSW) sections 14 — 20; Trustee Act 1958 (Vic) Part I; Trustees Act
1962 (WA) Part III, Trustee Act 1936 (SA) Part 1; Trustee Act 1898 (Tas)Part II; Trustee Act 1893 (NT) Part I; Trustee Act 1925 (ACT) Part 2
Division 2.2 Subdivision 2.2.1.

50

See, eg Trusts Act 1973 (Qld) s 21. The formulation in the NSW, Vic
and ACT legislation is: A trustee, unless expressly forbidden by thetrust instrument, may invest trust funds in any form of investment,
and vary an investment at any time.

51

SIS Act ss 52, 62.

52

Ibid s 62.

53

Ibid s 52(6)(a).

54

Ibid ss 52(6)(a)(i)-(vii).

55

Ibid s 52(2)(b).

56

Ibid s 52(3).

57

Ibid s 52(2)(c).

58

Ibid s 52(2)(d)(i).

59

Ibid s 52(8).

60Ibid s 52A.

61

Treasury Laws Amendment (Improving Accountability and Member
Outcomes in Superannuation Measures No. 1) Act 2019 (Cth).

62

Ibid s 52(12).

63

Ibid s 52(9).

64Ibid s 52(13).

65

The line of cases is analysed in Self Managed Superannuation
Fund Ruling SMSFR 2008/2 issued by the Australian Taxation

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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Office. SMSFR 2008/2 is being reviewed as a result of thedecision in Aussiegolfa Pty Ltd (as trustee of the Benson Family
Superannuation Fund) v Commissioner of Taxation (Cth) [2018]
FCAFC 122.
66

67

See, eg, Asea Brown Boveri Superannuation Fund No. 1 Pty Ltd v
Asea Brown Boveri Pty Ltd and Others [1999] 1 VR 144 in which
the Court held at [65]: ‘… trustees of a superannuation fund owe
a duty of loyalty exclusively to the members. It does not follow
from that, however, that a trust deed can never be altered to meetthe interest of the employer. Trustees are free to negotiate with
an employer for a package of amendments that may include
benefits to the employer if in the opinion of the trustees that would
benefit the members’. Also: Invensys Australia Superannuation
Fund Pty Ltd v Austrac Investments Ltd and Others [2006]
VSC 112; Aussiegolfa Py Ltd (as trustee of the Benson Family
Superannuation Fund) v Commissioner of Taxation (Cth) [2018]
FCAFC 122, Australian Prudential Regulation Authority v Kelaher[2019] FCA 1521.
This perspective is supported by Dominique Hogan-Doran ina presentation to the Law Council of Australia Superannuation
Lawyers’ Conference in 2019, who emphasised that, despite a literalreading of sole purpose test creating an impression that social
impact investing may be off-limits for superannuation funds, thesole purpose test does not ‘prohibit positive social outcomes’ andthat it permits the dual aims of financial return and of a social
or environmental return: Dominique Hogan-Doran SC, Current
Thinking on the Sole Purpose Test (Speech, Law Council of Australia
Superannuation Lawyers’ Conference, 2019) 17-18.

68

APRA Prudential Standard SPS 515, Strategic Planning andMember Outcomes, [16]-[17].

69

APRA Information Paper Heatmap – MySuper products (15November 2019), 21.

70See, comments in APRA Media Release dated 15 November 2019,attributed to Helen Rowell APRA Deputy Chair: ‘In most cases, thiswill be a continuation of the supervisory action that APRA has
already taken with these entities to address identified areas ofpoor member outcomes. If trustees don’t fix these issues within atimeframe that is acceptable to APRA, we will be requiring them toconsider other options, including a merger or exit from the industry
in some cases’.

71

Corporations Act s 912A.

72

Story v National Companies and Securities Commission (1988) 13
NSWLR 661, 69.

73

Ibid s 1013E.

74

Ibid s 1013D(l).

75

ASIC Regulatory Guide 65 – Section 1013DA disclosure guidelines(issued 30 November 2011) (ASIC RG 65) is issued under section
1013DA of the Corporations Act which provides that ‘ASIC may
develop guidelines that must be complied with where a ProductDisclosure Statement makes any claim that labour standards
or environmental, social or ethical considerations are taken into
account in the selection, retention or realisation of ‘investments’.

76

Corporations Regulations sch 10D, reg 7.9.11O, cl 9(c); Corporations
Regulations sch 10E, reg 7.9.11W, cl 7(c).

77See, ASIC RG 65.

78

Hutley and Mack; Barker et al: McAlister, Are you exposed:

190

Examining the potential liability of superannuation trustee
directors for failure to take account of climate change risk Banking& Finance Law Bulletin October 2015 Pam McAlister.
79

APRA Information Paper – Climate change: Awareness to action(29 March 2019) (APRA Information Paper on Climate Change), 17.
This information paper also refers to a report by ASIC on climate risk
disclosure by Australia’s listed companies in 2018. See also, APRA,
Understanding and managing the financial risks of climate change(24 February 2020).

98

Corporations Act s 601FC(1).

99

Ibid s 601GB.

100

Ibid s 601GA.

101

Ibid s 601GA(1)(b).

102

Re Smith & Fawcett Ltd [1942] Ch 304; Greenhalgh v Arderne
Cinemas Ltd [1951] Ch 286; Percival v Wright [1902] 2 Ch 421.

103

Corporations Act s 180(1).

80APRA Climate Paper.

104

Ibid s 181(1).

81Statement from Rest, Media Release, 2 November 2020.

105

Ibid s 181(2).

82

Corporations Act s 1017B.

106

Ibid s 182(1).

83

Statutory duties include the sole purpose test, the best interests
duty, the duty of care and skill, and the duty to promote the financial
interests of the members.

107

Ibid s 180(2).

108Bell Group Ltd (in liq) v Westpac Banking Corp (No 9) [2008] WASC
239.

109

EV Daniels and others (formerly practising as Deloitte Haskins &Sells) v Anderson (1995) 37 NSWLR 438.

110

Daniels (formerly practising as Deloitte Haskins & Sells) v Anderson(1995) 37 NSWLR 438, 494.

111

See paragraph 2.2.19.

112

Life Insurance Act 1995 (Cth) (Life Act) s 31.

113

Ibid s 38(2).

84

SPG 530, [34].

85

As of 24 June 2021, the Responsible Investment Association
Australasia identifies several Australian super funds that have beencertified as applying a responsible or ethical investment strategy(these funds include Australian Catholic Superannuation Retirement
Fund, UniSuper, Aware Super, VicSuper, sunsuper, Christian Super,
Future Super and Active Super) - https://www.responsiblereturns.
com.au/.

86

Treasury Laws Amendment (Improving Accountability andMember Outcomes in Superannuation Measures No. 1) Act 2019(Cth) introduced s 52(9) into the SIS Act, requiring APRA-regulated
trustees to covenant that the financial interests of beneficiaries arebeing promoted by the trustee.

114

Ibid s 32.

115

ACN 074 971 109 Pty Ltd (as trustee for the Argot Unit Trust) v The
National Mutual Life Association of Australasia Ltd (No 2) [2012]
VSCA 241, [108]: ‘It is the plain and ordinary meaning of ‘interestsof owners and prospective owners of policies referable to the fund’in s 32 is their interests as framed by their entitlements under the
Policies’.

87

Corporations Act s 1017B requires notification of material changes toa matters that was disclosed in a Product Disclosure Statement.

88

Letter from APRA to all APRA-regulated entities dated 24 February
2020.

116

Ibid s 30(f).

89Refer to paragraph 2.2.13.

117

Ibid s 43(2).

90

SIS Act ss 52(9), 52(11), 52(12), 52(13).

118

91

SPS 515 is discussed at paragraph 2.2.16.

92

APRA, ‘Review of APRA’s 2013 prudential framework’ Information
Paper (30 April 2019) https://www.apra.gov.au/sites/default/files/
information_paper_review_of_apras_2013_superannuation_
prudential_framework.pdf 37.

93

A managed investment scheme does not have to be registered if all
the issues of interests in the scheme that have been made would
not have required the giving of a Product Disclosure Statement
under Division 2 of Part 7.9 if the scheme had been registered when
the issues were made (eg if all the issues of interests in the scheme
have been made offered and made to ‘wholesale clients’ under
Chapter 7 of the Corporations Act): s 601ED.

Life Act, s 48. APRA Prudential Standard CPS 510 Governance (1July 2019) also imposes requirements for Board composition thathas regard to skills. At paragraph 19, the Board must ensure that
directors and senior management of the institution collectively havethe full range of skills needed for the effective and prudent operationof the institution, and that each director has skills that allow them tomake an effective contribution to Board deliberations and processes.
This includes the requirement for directors, collectively, to have thenecessary skills, knowledge and experience to understand the risksof the institution, including its legal and prudential obligations, andto ensure that the institution is managed in an appropriate way
taking into account these risks.

94

See, eg, ASX, Listing Rules (at 26 March 2021) rr 1.3.4, 4.10.20, 15.16.

95

The Corporations Act provides that responsible entities hold scheme
property on trust for scheme members: s 601FC(2).

96

Harries v Church Commissioners [1993] 2 All ER 300, 305 and, forexample, Trustee Act 1958 (Vic) ss 5—6.

97

Corporations Act s 601FC(1)(m); Wellington Capital Ltd v ASIC (2014)
254 CLR 288, [11] (French CJ, Crennan, Kiefel and Bell JJ).

119

Insurance Act 1973 (Insurance Act) s 28.

120

Insurance (prudential standard) determination No.8 of 2019:
Prudential Standard GPS 120 Assets in Australia.

121

APRA Prudential Standard CPS 220, Risk Management [19].

122

APRA Prudential Standards LPS 110, 112, 114, 115, 117, 118; APRA
Prudential Standards GPS 110, 112,114, 115,117,118, 120.

123

APRA Climate Paper.

124

APRA Prudential Standards GPS 110, 112,114, 115,117,118, 120.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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AUSTRALIACONTENTSFOREWORDSINTRODUCTION
125

APRA Prudential Standard GPS 110 [11(b)].

126

APRA Climate Paper 17.

127

APRA Climate Paper.

128

APRA Prudential Standards LPS 110, 112, 114, 115, 117, 118.

129

APRA Prudential Standard LPS 110 Capital Adequacy, [13(b)].

130Life Act s 36.

131

Ibid s 32(b).

positive duty to take action to address these risks: see paragraph2.2.17.
147

Joanna Mather, ‘Put members’ returns ahead of activism, Samueltells super funds’, Australian Financial Review (online), 11
September 2019, https://www.afr.com/companies/financial-services/put-members-returns-ahead-of-activism-samuel-tells-super-funds20190911-p52q7l.

148

APRA Information Paper, Climate change: Awareness to action (20March 2019).

132

Ibid s 48(3).

149

133

Corporations Act s 1013D(l); Corporations Regulations, reg 7.9.14C;
ASIC RG 65.

Treasury Laws Amendment (Design and Distribution Obligations
and Product Intervention Powers) Act 2019 (Cth).

150

134

Corporations Act s 1017B.

ASIC Consultation Paper 325: Product design and distribution
obligations, [27].

135

APRA Climate Paper 17.

151

See Corporations Act ss 136(2), 601GC(1).

136

RG 128 at RG 128.2.

137

RG 128 at RG 128.49-50.

138

Australian Council for Superannuation Investors (ACSI) Stewardship
Code (2018), principle 3 (p 11 discussion).

139

The Financial Services Council’s (FSC) Standard 23: Principles ofInternal Governance and Asset Stewardship (July 2017) [2.3.3].

140

Anecdotally, the hearings conducted by the Royal Commission into
Misconduct in the Banking, Superannuation and Financial Services
Industry were seen as contributing to severe reputational damage
for Australia’s major banks, and their subsidiaries that are APRAregulated trustees, which resulted in significant outflows of member
funds from their superannuation funds.

141

142

Financial Services Council Life Insurance Code of Practice, [3.1].

153

Templates have been released by the Financial Services Council(FSC), and the Association of Superannuation Funds of Australia(ASFA).

154

See paragraph 2.2.19.

155

SIS Act s 116.

156

ASIC v Citigroup Global Markets Australia Pty Ltd (No 4) [2007] FCA
963.

157

Astley v Austrust Ltd (1999) 197 CLR 1.

158

It is worth noting that Australian practitioners keenly await further
developments in the United Kingdom following the decision of
Vedanta Resources plc and another v Lungowe and others [2019]
UKSC 20, a jurisdictional decision of the UK Supreme Court whichsuggests that parent companies that are significantly involved in theaffairs of their subsidiaries may owe a duty of care to third parties
harmed by the acts of those subsidiaries. The decision (and othersin the Commonwealth that may be decided in light of it) also holds
some persuasive value for Australian courts, and is in line with agrowing focus on human rights by the Australian Parliament andjudiciary.

Cara Waters, ‘Biggest super fund vows to vote against companies
with one woman boards’, Sydney Morning Herald (online), 15
September 2019, https://www.smh.com.au/business/companies/
biggest-super-fund-vows-to-vote-against-companies-with-onewoman-boards-20190913-p52qwv.html.
Noel Hutley and James Mack, ‘Memorandum of Opinion: Market
Forces – Superannuation Fund Trustee Duties and Climate Change
Risk’ (15 June 2017), available at https://www.envirojustice.org.au/sites/default/files/files/20170615%20Superannuation%20Trustee%20
Duties%20and%20Climate%20Change%20(Hutley%20%26%20
Mack).pdf; Sarah Barker, Mark Baker-Jones, Emilie Baron, Emma
Fagan, ‘Climate change and the fiduciary duties of pension fundtrustees – lessons from the Australian law’ (2016) 6(3) Journal of
Sustainable Finance & Investment 211; Pam McAlister, ‘Are you
exposed: Examining the potential liability of superannuation trustee
directors for failure to take account of climate change risk’ (October2015) Banking & Finance Law Bulletin.

143

ASX Corporate Governance Council, Corporate GovernancePrinciples and Recommendations, (4th ed, February 2019)
Recommendation 7.4.

144

See paragraphs 3.2.4 to 3.2.6 for consideration of the duties of
directors of LICs with respect to stewardship.

145

See paragraphs 3.2.4 to 3.2.6 for consideration of the duties
of directors of listed investment companies with respect tostewardship.

146

For example, legal commentary on consideration of climate changerisks includes analysis of the sole purpose test, best interests duty,
and the duty of care and skill, and suggests that trustees have a

191

152

159

See Sullivan v Moody (2001) 207 CLR 562, [55] — [62]; Caltex
Refineries (Qld) Pty Ltd v Stavar (2009) 75 NSWLR 649.

160

See Barrow v CSR Ltd (Unreported, 4 August 1988, Supreme Courtof Western Australia, Rowland J); CSR Ltd v Wren (1997) 44 NSWLR
463 and CSR v Young (1998) Aust Tort Reports 81-468.

161

In CSR Ltd v Wren (1997) 44 NSWLR 463, a majority of the Supreme
Court of New South Wales (on appeal) accepted the trial judge’s
conceptualisation of the requisite degree of control as being aparent company’s exertion of ‘dominant, pervasive, constant andcontrolling’ influence such that there is a ‘necessary relationship ofproximity’ so as to give rise to a duty of care: 476.

162

See, National Contact Point, ‘View a closed complaint’ https://ausncp.
gov.au/complaints/view-closed-complaint (accessed 15 July 2020).

163

See, eg, OECD Watch Case Database, EC and IDI v Australia and
New Zealand Banking Group.

164

SPG 530.

165

APRA, Understanding and managing the financial risks of climatechange (24 February 2020).

166

Ibid.

167

APRA Information Paper, Climate change: Awareness to action (20March 2019). See also APRA, ‘APRA to step up scrutiny of climate
risks after releasing survey results’ (Media Release, 20 March 2019).

ACKNOWLEDGEMENTS

168

See, eg, ASIC RG 228, ASIC RG 227, ASX Principles andRecommendations.

EXECUTIVE SUMMARY

169

Address by ASIC Commissioners Sean Hughes and Cathie Armour,‘ANU Climate Update’ (Canberra, Sydney and Adelaide, 7 February
2019, 21 February 2019 and 4 March 2019) where it was stated that
ASIC considers it misleading for directors to discuss a company’s
prospects without referring to business risks, which could include
climate change. See ASIC ‘ASIC updates Guidance on climate
related disclosure’ (Media Release 19-208MR, 12 August 2019)
where it was stated ASIC will conduct surveillance of climate change
related disclosure practices by certain listed companies.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSI170

EJA Comms, ‘Climate Change Risk Disclosure Case Goes before theFederal Court’, Environmental Justice Australia (Media Release, 8
August 2017) https://www.envirojustice.org.au/climate-change-riskdisclosure-case-goes-before-the-federal-court/.

171

Discussed at paragraph 9.2(a) above.

172

See, eg, Guy Debelle, Reserve Bank of Australia, ‘Climate Change andthe Economy’ (Speech, Public Forum hosted by the Centre for Policy
Development, Sydney, 12 March 2019).

173

See our discussion at 9.2(b).

174

See, for example. FSC, FSC Standard No. 13: Voters Policy, Voting
Record and Disclosure (2013). This is a mandatory standard of which
the FSC has formal oversight of.

175

See, for example, FSC, Standard No.20: Superannuation
Governance Policy (2012). This is a mandatory standard of which the
FSC has formal oversight of.

176

FSC and ACSI ESG Reporting Guide for Australian Companies(2017). See also, Climate Related and other emerging risks
disclosures: assessing financial statement materiality using AASBPractice Statement 2’ (December 2018).

Brazil177

FSC, FSC Standard 23: Principles of Internal Compliance and Asset
Stewardship (2017). This is a mandatory standard of which the FSC
has formal oversight of.

China

178

See Centre for Policy Development, Business Roundtable on Climate
and Sustainability, 21 November 2019, Remarks by Kenneth Hayne
AC QC https://cpd.org.au/2019/12/full-text-of-kenneth-hayne-acqc-remarks-to-cpd-climate-roundtable/; Noel Hutley and SebastianHartford-Davis, ‘Climate Change and Directors’ Duties’ (2016), The
Centre for Policy Development and Future Business Council; seealso Noel Hutley and Sebastian Harford-Davis, ‘Climate Change andDirectors’ Duties’ (2019), The Centre for Policy Development andFuture Business Council, 3 — 7.

179

Corporations Act s 677.

180

AASB Practice Statement, ‘Making Materiality Judgments’,Statement 2, December 2017, para. 5. The definition appears in
AASB standards AASB 1048 Interpretation of Standards (para.
[QC11]), AASB 101 Presentation of Financial Statements [7] andAASB 108 Accounting Policies, Changes in Accounting Estimatesand Errors [5]. AASB accounting standards are available through thefollowing link: https://www.aasb.gov.au/Pronouncements/Currentstandards.aspx.

181

ASX Listing Rules, Guidance Note 8, Continuous Disclosure: Listing
Rules 3.1 — 3.1B https://www.asx.com.au/documents/rules/gn08_

C. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

CanadaEuropean Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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continuous_disclosure.pdf 7.
182

ASX Principles and Recommendation, Principle 7 (Recognise andmanage risk), Recommendation 7.4.

183

Ibid 28.

184

FSC, Guidance Note no. 30, ‘ESG Reporting Guide for AustralianCompanies’ (2015), 6.

185

SASB, ‘Why is Financial Materiality important?’ https://www.sasb.org/
standards-overview/materiality-map/.

186

SASB, Materiality Map, https://materiality.sasb.org/.

187

AASB, ‘Climate-related and other emerging risks disclosures:assessing financial statement materiality using AASB PracticeStatement 2’, December 2018. https://www.aasb.gov.au/admin/file/content102/c3/AASB_AUASB_Joint_Bulletin_13122018_final.pdf.

188

APRA Information Paper Heatmap – MySuper products November
2019, 12.

189

See generally ‘Corporate responsibility: Managing risk and creating
value’, report by the Parliamentary Joint Committee on Corporations
and Financial Services, 21 June 2006, Chapter 5, paras 5.15-5.19.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

192

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BRAZILCONTENTSFOREWORDSINTRODUCTION

1.

INTRODUCTION

1.1

This annex considers the laws of theFederative Republic of Brazil as at 31
January 2021. Sections 2 to 4 address
the ability of Asset Owners to pursue‘Investing for Sustainability Impact’ (IFSI)
where the relevant portfolio does not havean express Sustainability Impact objective.

1.2

As discussed in the main body of thereport, the expression ‘Investing for
Sustainability Impact’ is not a term ofart. Rather, the expression is used here asa type of ‘conceptual net’ to denote any
power or freedom on the part of Asset
Owners or their Investment Managers to
pursue one or more Sustainability Impact
objectives whether in order to protect
or enhance the financial performance of
their investment (instrumental IFSI) or
otherwise (ultimate-ends IFSI).

The following key feature of Brazilian law apply tomultiple relevant investors:
1.3

Social function of ownership and social
function of contract

1.3.1

Under Brazilian law, (a) all assets in Brazil
are subject to the ‘social function ofownership’1, and (b) all contracts governedby and construed in accordance with
Brazilian law are subject to the ‘social
function of contract’2-3 . Such principles
suggest that property and contracts shallperform a social role in the Brazilian
economic order – which, in turn, isfounded on the social values of labour 4
and free enterprise 5.

ACKNOWLEDGEMENTS

1.3.2

1.3.3

It is generally understood that the
principles of the social function ofcontract and ownership apply to all
entities comprising the Brazilian economy.
Thus, a series of duties imposed on theperformance of economic activities may
be justified by such principles, including
the prohibition of price abuse under
antitrust law and the liability imposedon companies by reason of misleading
propaganda and/or product defects inrelation to their consumers 6.
Furthermore, it could be argued thatthese principles guide all contracts
to the fundamental objectives statedin the Federal Constitution, namely
human dignity, eradication of poverty,
decrease of inequality and an ecologicallybalanced environment, among others.
The social function is a matter of jus
cogens and therefore cannot be waived
contractually 7. In line with that, theFederal Constitution expressly statesthat the economic order of Brazil has the
purpose of assuring all citizens a dignified
existence, observing the principles of,among other things, (a) the social functionof ownership and (b) the defence of theenvironment, including by providing
a different treatment according to theenvironmental impact associated withproducts made and services rendered.

1.3.4

1.3.5

On this basis, IFSI is consistent withthe rationale for the social function ofownership and contract and it could beargued that setting Sustainability Impact
objectives for a portfolio would fulfil thesocial function of owning said assets.
Likewise, managing a portfolio pursuing
positive Sustainability Impact, irrespectiveof the objective established in theinvestment policy, would be a way to fulfil
the social function of the managementagreement, through which the Investment
Manager was engaged 8.
As per the social function of ownershipand of contract, one could argue that all
Asset Owners have an implicit duty to use
best efforts to at least minimise negative
Sustainability Impacts, since this would
promote social justice and aim for thebest balance for the natural environment
and wider well-being, as intended by
the Federal Constitution 9. Therefore, asa result of the legal principle of social
function of ownership and of contract, it
is possible to argue that Relevant Investors
may engage in ultimate ends and/or
instrumental IFSI, according to the limits
set by the legal framework and by theapplicable contracts providing the duties
and powers of such Relevant Investors.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia
BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

193

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1.3.6

1.4
1.4.1

194

It is important to note that the discussion
presented herein with regard to an
investment decision-maker justifying IFSI
if the respective Asset Owner’s by-laws are
silent on the matter by reference to thesocial function of ownership and contract
has never been tested in a Brazilian
court of law. As a result, at this time,
the social function supremacy argument
should be considered as a framework
within which Relevant Investors would
be allowed to pursue ultimate-ends and/or instrumental IFSI, but not required to
do so. Notwithstanding that, we cannot
predict the outcome of a dispute regarding
compliance with an investment policy or
payment requirements if such obligations
are not met because a Relevant Investor
pursued Sustainability Impact instead of, orin addition to, financial return, irrespectiveof the investment policy objectives.

obligation to consider what, if anything,
it can do to mitigate that risk, using themeans at its disposal (eg investment powers,
stewardship, policy engagement
or otherwise) and to act accordingly.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

Duties that could arise from regulations

BrazilDuties arising from pension funds, mutual
funds or insurance regulations generally
applicable to the investment decisionmakers of each Asset Owner 10– as will
be discussed in detail in Sections 2 to 4
and 6 below – may be relevant to support
construing instrumental IFSI as a legal duty,
ie when facing a situation where achieving
the relevant Sustainability Impact goalis ‘instrumental’ in protecting the Asset
Owner’s financial performance. Hence,
if such an investment decision-maker, on
the available evidence ought to conclude
that one or more sustainability factors
poses a material risk to its ability to realise
the Asset Owner’s financial investment
objectives, it will generally have a legal

CanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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BRAZILCONTENTSFOREWORDSINTRODUCTION

2.

ASSET OWNERS’ USE OF POWERS OF INVESTMENT AND DIVESTMENT TO INVEST FORSUSTAINABILITY IMPACT

2.1

The following section considers the extent
to which and in what circumstances eachtype of Asset Owner is (a) legally requiredor (b) legally permitted or able to use its
powers of investment and divestment topursue IFSI.

2.2

Pension funds

Types of pension fund covered
2.2.1

purpose and organised as a non-profit
organisation (with legal personality).
Pension Funds have the objective ofproviding private assistance to their
Beneficiaries, which is done by theprovision of financial security and theestablishment of a mechanism for longterm savings.

Due to their size and relevance in theBrazilian capital and financial markets,
this analysis considers exclusively closed
private pension plan entities (entidades
fechadas de previdência complementar –hereinafter referred to as Pension Funds).
Open private pension plan entities(entidades abertas de previdência complementar– OPPE) are addressed in 2.4 below.

2.2.3

2.2.4

• Asset Owner: Pension Funds.
• Beneficiaries: current and past

contributors – who are or were employees
or associates of the Pension Funds’
sponsor (as defined in 2.2.5 below) andpresent or future beneficiaries.
• Investment decision-maker: directors,

administrators, investment committee
members of the Pension Funds orprofessional Investment Managers
authorised by the Securities and Exchange
Commission of Brazil (Comissão de Valores
Mobiliários – CVM) to manage portfolios ofpension plans, as the case may be.
2.2.2

195

Pension Funds are entities organised as
civil society organisations or foundations,which under Brazilian law are defined
as pools of assets allocated to a certain

2.2.5

To ensure its ultimate and exclusive
purpose, which is to pay benefits for the
Beneficiaries, a Pension Fund collects thecontributions due by the participants andthe sponsors (as applicable) and manages
these third parties’ resources by investingaccording to specific rules.

contribution 11, which entitles theemployee or associate, or a beneficiaryindicated thereby, to receive a pension
upon retirement.
Overview of investment duties and powers
2.2.6

2.2.7

Pension Funds may engage, through aninvestment management agreement,a professional Investment Manager
authorised by CVM to manage theportfolios of pension plans with the
purpose of paying pensions to retirees of
one specific legal entity or of a group of
legal entities.
A Pension Fund manages one or more
pension plans that may only be accessedby the employees of a company (private
or public), as well as career employees offederated units (the federal government,
Brazil’s states, the federal district, andthe municipalities) or the associatesof a professional association or union;
the company, the federated units, theclass association or union, as the casemay be, figures as the plan’s sponsor.
The employee or associate who chooses
to participate in a plan pays a monthly

2.2.8

Pension Funds have the power to establish
and operate pension plans, which mustobserve technical rules with the purposeof assuring transparency, solvency,
liquidity and the pension plans’ financial,economic and actuarial health.
Pension Funds must have their pension
plans’ portfolios managed with regard
to the actuarial obligations thereof andto the cash flow of payments, in order toachieve a balance between their benefit
pay-outs and income rate. When setting
the investment policies – including theirfinancial return goals – of the pension
plans they manage, Pension Funds musttake into account a horizon of at least
60 months, with annual reviews, which
are typically based on the plan category,
Beneficiaries’ life expectancy, interest
rates of the assets comprising the portfolio
and other factors that could potentiallyaffect the Pension Funds’ investments 12.
Pension Funds are not legally required toinvest in certain categories of enterprises
or jurisdictions. Nonetheless, Pension
Funds must comply with legal andregulatory provisions regarding crimesof money laundering or concealment ofassets, rights and valuables, as well as laws
regarding the combating the financing ofterrorist activities 13.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia
BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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2.2.9

The regulation applicable to Pension Funds
14
does not determine the maximisationof profit as their sole purpose, but due totheir duty to follow the principles of safety
and profitability and meet their actuarial
obligations, one could argue that Pension
Funds would be implicitly obliged to seek
profit), even if their primary financial
return goals are achieved, since they would
not have permission to prioritise certain
kinds of investments or seek goals otherthan the ones provided in the pension
plan’s investment policies.

2.2.10 Recent episodes of corruption involving
Pension Funds in Brazil have induceda shift in Pension Funds’ and their
Investment Managers’ behaviour, whereby
they have become much more active inthe due diligence pre-, post and during theinvestment process, not only regarding theassets invested in but also their respective
managers. One of the consequences ofthis activism is the recent increase inlitigation and internal investigations(sindicâncias) conducted by Pension Funds.
These changes have led the Pension Funds’
investment decisionmakers to be reluctant
to engage in activities or take investment
decisions that are not explicitly
established in the regulations in force and/or in pension plan’s investment policies.
2.2.11 The applicable regulations regarding
investment of reserves by Pension Funds(a) determine that such investments must
be managed (i) in good faith and diligently
with loyalty to the Beneficiaries and thepension plan itself and (ii) in a way thatseeks to maintain high ethical standards,
which could be an argument for the196

requirement to invest the Pension Funds
portfolio so as to secure the wider wellbeing of Beneficiaries (eg not investingin certain sectors that may jeopardisesociety or the environment); and (b) do
not specifically address how possible
conflicts between different categories ofBeneficiaries are to be resolved.
2.2.12 Additionally, the regulations applicable
to Pension Funds do not require them to(a) disclose information to the market ingeneral, but only to regulators and their
Beneficiaries; or (b) engage in
stewardship activities.
Legal requirements to use investment powers to
pursue IFSI
2.2.13 Despite the need to observe the social
function principle as mentioned in
Section 1 above, the rules for Pension
Funds’ investments fail to encompass
objective criteria and measures to achieve
Sustainability Impact, which leads tosignificant uncertainty as to the extent towhich Sustainability Impacts are required
to be taken into account by the Pension
Funds when establishing their investment
portfolios in an ultimate-ends IFSI
perspective. However, from an instrumental
IFSI perspective, the latest regulations
establish that Pension Funds should
consider aspects related to the economic,
environmental, social and governancesustainability of their investments,
whenever possible 15, in their risk analysis;see 1.5.1 above as regards instrumental IFSI.
2.2.14 Pension Funds must include, in theinvestment policies of the pension plans
they manage, guidelines for observing
ESG principles preferentially segregatedfor each industry they invest in 16. On thedate hereof, there is no case law regarding
what those guidelines should or should
not encompass.
Legal freedom to use investment powers to pursue IFSI
2.2.15 Although the current laws and regulations
do not create any express obligation for
Pension Funds to pursue IFSI, considering(a) the social function of ownership andof contract, and (b) the long-term natureof a Pension Funds’ investment schemes,
which (i) are closed-end, and, therefore,
allow redemptions before the disability,
retirement or death of the Beneficiary
only in specific circumstances, and (ii)have an indefinite term, and whereas
contributions made will typically only
need to be repaid many years ahead, thePension Funds’ pension plan could pursue
IFSI provided its legal and regulatory
obligations are fulfilled 17. This isbased on the argument that (as regards
instrumental IFSI) it is thus protecting
the portfolio’s net value in the long term18
and (as regards ultimate-ends IFSI)
fulfilling the social function of ownershipand of contract provided in the Federal
Constitution and in the Civil Code.
2.2.16 However, as per Pension Funds’ actuarial
obligations stated in 2.2.7 above andthe need for strict compliance with theprovisions of the Pension Funds’ rules
described in 2.2.9 above, any investments
made thereby to pursue Sustainability
Impact goals would always be subject tothe provisions of the by-laws, applicableregulations and contracts and to theirprimary pursuit of financial return in order
to meet their actuarial and financial duties.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia
BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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2.3

Mutual funds

categories of financial assets and issuer
concentration limits; and (e) periodicallydisclosing to all quotaholders and to theCVM certain documents and information
related to the fund 21.

Types of mutual fund covered
2.3.1

2.3.2

There are many types of Brazilian
investment funds 19, all of which areorganised as a special condominium,
hence they have no legal personality. Suchinvestment funds issue quotas, which are
securities that denote ownership in thecondominium and are subscribed for by
the fund’s investors.

2.3.4

This analysis covers all types of Brazilian
investment funds, notwithstanding thatcertain conclusions hereof may be affectedby specific regulation applicable to eachtype of fund.
• Asset Owner: investment fund.
• Beneficiaries: holders of quotas throughout

the fund’s term (quotaholders).
• Investment decision-maker: professional

2.3.5

Investment Manager authorised by the
CVM to manage securities portfolios 20.
Overview of investment duties and powers
2.3.3

197

The main duties and powers that an
investment fund’s fiduciary administrator
and Investment Manager have consist in:(a) carrying out their activities in goodfaith, transparency and loyalty in relation
to the quotaholders; (b) seeking to meetthe quotaholders’ investment objectives
and avoid practices that may jeopardise
the fiduciary relationship maintained
towards the quotaholders; (c) complying
with the resolutions of the quotaholders’general meeting; (d) complying with andenforcing all the provisions of the fund’s
by-laws (regulamento); and other provisions
that are specific to each type of fund,including diversification rules regarding

2.3.6

2.3.7

The powers specifically attributed toInvestment Managers consist, briefly, in
analysing and selecting investments andallocating resources of the investment fundin the market. Fiduciary administrators’
specific functions consist in, for instance,
representing the fund in and out of court,
convening quotaholders’ general meetings,
engaging the fund’s service providers andkeeping the fund’s documents 22. Typically,
fiduciary administrators will engage an
Investment Manager or perform themselves
activities related to portfolio management if
they are authorised by the CVM to do so.

specifically address how possible conflicts
among quotaholders of different classes
are to be resolved; and (b) determine that
Investment Managers must act (i) in goodfaith and diligently and with loyalty to thefund, and (ii) in a way that does not breach
their fiduciary duties towards investors,
which could be an argument for therequirement to invest the fund’s portfolio
so as to secure the wider wellbeing of
quotaholders and society (eg not investingin certain sectors that may jeopardisesociety or the environment), always
without prejudice to their obligation toseek financial return if no other goal isprovided in the by-laws.
Legal requirements to use investment powers to
pursue IFSI
2.3.8

Brazilian investment funds are notlegally required to invest or to refrainfrom investing in certain categories ofenterprises 23.
Investment funds’ Investment Managers andfiduciary administrators (a) must establish
rules, procedures and internal controls toassure the fulfilment of their obligations
pursuant to applicable regulation and adopt
a code of ethics; and (b) must comply withlegal and regulatory provisions regarding
crimes of money laundering or concealmentof assets, rights and valuables 24. Whenprospecting investments these requirements
may limit the companies and jurisdictions
eligible for investment.
The regulations applicable to investment
funds (a) determine that situations ofconflict of interest must be taken to thequotaholders’ general meeting, but do not

2.3.9

Brazilian legislation and regulation
provide that investment funds may
invest in varied securities, assets andrights, pursuant to the investment policy
established in the by laws 25, and somespecific laws and rules establish further
limitations on those securities, assets andrights. There are no laws or regulations
defining what the investment policy’s
objectives need to be 26.
It should be noted that investment funds
do not have investment or divestment
powers on their own: these powers are
entirely held by the Investment Managers
27. CVM rules state that it is part of theInvestment Manager’s duties to comply
with the provisions of the investment
fund’s by-laws. Therefore, if the by-lawsof a certain fund provide the need to takeSustainability Impact factors into accountwhen making investment or divestment
decisions regarding the investment fund’s

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia
BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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portfolio, the Investment Manager would
be contractually required to observe said
criteria and could be held liable for notdoing so. In other words, these criteria
are not legally mandated to be in an
investment fund’s by-laws, but if they
happen to be stated therein, the duties of
the Investment Manager oblige it to comply
with them (see 1.5.1 on instrumental IFSI).
Legal freedom to use investment powers to pursue
IFSI
2.3.10 In spite of the applicability of the social
function principle to all economic activities
as explained in Section 1 above, it would
not be possible for an Investment Manager
to pursue Sustainability Impact (subject
to this being legally mandated in theinvestment fund’s by-laws) if such a pursuit
is isolated from financial return and clearly
and in an ex ante analysis jeopardises or iscontrary to seeking profitability.
2.3.11 Notwithstanding the above, it isarguable that even when the pursuit of
Sustainability Impact is not expressly
stated in the by-laws of the investment
fund, if (a) there is wording related to the
pursuit of long-term returns; and (b) areasonable link could be made between
the long-term profitability and likelihoodof success of investments and their
Sustainability Impact, the Investment
Manager could invest in potentially positive
Sustainability Impact projects, regardlessof potential lower short-term returns andwithout prejudice to its liability towards
the CVM or quotaholders, which could
be considered as an instrumental IFSI
investment strategy. It should be noted,
however, that there is no clear definition

198

for the timeframe in which this assessment
should be carried out.
2.3.12 Likewise, if an Investment Manager
reasonably concludes that sustainability
factors pose a risk to its financial investment
objectives, it would be compelled to act
accordingly and take appropriate measures,subject to the provisions of the by-laws
and the relevant investment managementagreement, to mitigate such risk. Suchmeasures include, but are not limited to, theexercise of voting rights, by the Investment
Manager on behalf of the fund, in a way
to develop sustainability policies andprocedures in a fund’s investee.
2.3.13 Furthermore, a significant amount ofBrazilian investment funds’ by-laws
determine that the Investment Manager’s
performance fee shall only be collected
and due if the fund’s profits reach acertain benchmark 28. In this sense, if IFSI
has a higher chance of causing the fundto obtain less profit in the short term,
Investment Managers might tend not totake Sustainability Impact aspects into
consideration when selecting investments
for the fund’s portfolio.
2.3.14 On the other hand, there is a growing
environment encouraging the exercise
of powers of investment/divestment
for promoting positive Sustainability
Impact. For example, in January 2020,
the Brazilian Association of Financial andCapital Markets Entities (Associação Brasileiradas Entidades dos Mercados Financeiro e deCapitais – ANBIMA) published the ANBIMAESG Guide for the Incorporation of ESG
factors in investment analysis (ANBIMAESG Guide), which recommends bothmethodologies 29 and criteria 30 for adopting
ESG factors when investing 31. These andother industry participants’ guidelines
might encourage Investment Managers to
use their powers to pursue IFSI in order not
to miss out on strategies employed by theirpeers in the industry.
2.3.15 Notwithstanding the provisions above,
the flexibility to pursue IFSI is limited bycompliance with applicable regulations,notably with the diversification rules
regarding categories of financial assets
categories and issuer concentration limits,which are established with the purposeof not overexposing the fund to risks
associated with a particular issuer or
financial asset.
2.4

Insurance undertakings

Types of insurance undertaking covered 32
2.4.1

Due to their size and relevance in theBrazilian financial and capital markets,
this analysis covers exclusively OPPE
33
, insurance companies and local
reinsurance companies.
• Asset Owner: (a) OPPE; (b) insurancecompany; and (c) local reinsurancecompany – collectively hereinafterreferred to as Insurance Undertakings.
• Beneficiaries: (a) for OPPE: past andpresent contributors and present or
future beneficiaries ; (b) for insurancecompanies: (i) the insured parties andthose appointed thereby as beneficiaries,and (ii) holders of securities issued
by the insurance company, including
its shareholders; and (c) for local
reinsurance companies, the reinsured
parties (insurance companies, other local

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia
BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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BRAZILCONTENTSFOREWORDSINTRODUCTION

reinsurance companies, Pension Funds
and healthcare companies), and holdersof securities issued by the reinsurancecompany, including its shareholders.

Life insurance companies

General insurance companies

2.4.6

Life insurance companies and theirofficers and directors are subject to thesame duties mentioned for Insurance
Undertakings in 2.4.12 to 2.4.15 above

2.4.10 General insurance companies and theirofficers and directors are subject to thesame duties mentioned for Insurance
Undertakings in 2.4.12 to 2.4.15 above

2.4.7

However, there are two types of products
operated by life insurance companies forwhich the regulation establishes different
investment conditions: (a) life insurancewith survival coverage products, and(b) open private pension plans (thatcan be managed by both OPPEs and life
insurance companies).

2.4.11 The premiums for general insurance
products paid by all insureds thatpurchased the same type of productestablish a common set of assets which
are used to pay indemnifications in theevent of loss.

• Investment decision-maker: executive

board, investment committee or financial
officer, as applicable.
2.4.2

2.4.3

2.4.4

2.4.5

199

OPPEs are organised as corporations andprofessionally manage pension plans
opened for anyone to join at any time.
Participants are free to transfer theircontributions between plans, as well as
redeem the amount of their payments
according to the rules set forth by the plan.

2.4.8

Insurance companies are also organised ascorporations and their main purpose is tosell individual and collective insurance. Asa rule, the insurer defines the terms underwhich financial compensation would
be payable to the insured party or to abeneficiary appointed by the insured party
upon occurrence of a given event.
Local reinsurance companies areorganised as corporations as well. They
share part of the risks that are taken by
insurance companies, other reinsurancecompanies, Pension Funds and healthcarecompanies in exchange of a reinsurance
premium paid by the reinsured party
to said reinsurance companies. Local
reinsurance companies may also share therisks taken with other local reinsurancecompanies – this operation is usuallyreferred to as ‘retrocession’.
In Brazil, Insurance Undertakings are
regulated by the same supervisionauthority: SUSEP 34.

2.4.9

Life insurances providing survival
coverage and open private pension plans
have individualised reserves formed by
the payment of contributions which are,on their turn, injected into investment
funds constituted by the insurancecompany (since both types of products aremarked by the feature of accumulation ofreserves, ie capitalisation system).
According to the applicable regulation 35,
the resources collected from the insureds
and the participants must be allocatedto special purpose investment funds(funds-of-one), the sole quota holders ofwhom are the relevant OPPEs or insurancecompanies. These special purpose
investment funds shall then invest in
securities and other assets, pursuant to
all rules applicable to these types of Asset
Owners, as discussed in 2.3, 3.9, 4.5 and5.3 herein and pursuant to the applicableregulations enacted by the CMN 36.

Overview of investment duties and powers
2.4.12 OPPE have the power to establish andoperate pension plans, which mustobserve technical rules to assuretransparency, solvency, liquidity and thepension plan’s financial, economic andactuarial health.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

2.4.13 All Insurance Undertakings are organised
as corporations 37, thus their officers
and directors are legally required tofulfil specific fiduciary duties to thecorporation, namely: duty of diligence 38;
duty to pursue the company’s interest 39;
duty of loyalty to the company 40; duty
not to act in case of conflict of interests 41;
and, if the corporation is publicly held 42,
duty to inform 43.

Australia

2.4.14 Moreover, Insurance Undertakings must
grant access to SUSEP in regard to thecomposition of all of their portfolios ofassets, as well as periodically submit theirfinancial statements to SUSEP 44.

Netherlands

2.4.15 Apart from these legal duties, there
is a general regulatory framework 45
applicable to the investment of Insurance
Undertakings’ reserves which, among
other provisions, establishes that

BrazilCanadaChina

European Union
FranceJapan

South Africa
United Kingdom
United States

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Insurance Undertakings must (a) follow
the principles of safety, profitability,
solvency, liquidity, transparency,
diversification and adequacy for thenature of their obligations; (b) exercise
their activities in good faith and diligently
and with loyalty to the company; (c)seek to maintain high ethical standards;(d) adopt practices that permit thefulfilment of their investment policy; and,(e) whenever possible, observe aspectsof ESG sustainability in relation to theinvestments thereof.
2.4.16 Once a year, corporations are required tohold an ordinary shareholders meeting,in which the shareholders will consider aresolution on the corporation’s managers’
proposal for allocating the last fiscal
year’s earnings. If the pursued strategy
for IFSI involves distributing a smaller
portion of the earnings and reinvestingit, the inclusion thereof in the managers’
proposal would be legally required 46.
2.4.17 The specific legislation applicable toinsurance and local reinsurance companies
establishes guidelines for the National
Private Insurance Policy (Política Nacional de
Seguros Privados) 47, which intends to foster
the insurance market and to coordinate its
objectives with the federal government’s
investment policy. Pursuant to this notion,
one of its objectives is to provide forthe necessary operational conditions tointegrate the insurance market in the socialand economic process of the country, as
well as to preserve solvency and liquidity of
insurance and local reinsurance companies.

200

Legal requirements to use investment powers to
pursue IFSI
2.4.18 The legal framework that relates toInsurance Undertakings’ investments does
not provide express requirements for themto pursue IFSI. This renders it uncertain
as to the extent to which Sustainability
Impact is required to be taken into accountby these entities when selecting assets fortheir investment portfolio, in an ultimateends IFSI perspective.
2.4.19 However, from an instrumental IFSI
perspective, the applicable regulations
require Insurance Undertakings to consider,whenever possible 48, ESG factors in theirportfolio allocation 49. Even though theregulations are vague about the objectivesof this requirement and fail to specify
the requirements that must be fulfilledin this allocation, the reference to ESG
factors could be construed as an attempt toencourage ISFI; see also 1.5.1 above.
2.4.20 Additionally, since Insurance
Undertakings are corporations, they are
profit-seeking entities 50 and profitability
must not be weighted with lessimportance in decision-making than IFSI.
2.4.21 In this context, the applicable legislation
states that the National Private Insurance
Policy aims to ‘promote the necessary
operational conditions to integrate theinsurance market in the economic andsocial progress of the country’. ‘Economic
and social progress’ could be understoodas reference to principles stated in theFederal Constitution subjecting all
economic relations to considerations offairness, respect for human dignity andthe preservation of the environment,
which could be construed as an indirect

requirement to consider Sustainability
Impact in their portfolio allocation
analysis. However, as previously
mentioned, there is no direct reference tosuch requirement in the law.
Legal freedom to use investment powers to pursue
IFSI
2.4.22 There is no legal impediment for Insurance
Undertakings to pursue IFSI. However, theapplicable law lacks specific criteria thatshould be met by these corporations:• with the purpose of maintaining balance

between their duties – especially those ofmanaging solvency, ie being able to pay
policyholders’ claims – and investments
for Sustainability Impact; and• with the purpose of maintaining balance

between their directors’ and officers’
duties – especially those of generating
value to the shareholders – andinvestments for Sustainability Impact.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia
Brazil

2.4.23 We understand that insurance andreinsurance companies would not have tocomply with prudential regulations enacted
by the CMN in relation to the portion of
their resources that do not constitute theirtechnical reserves or technical provisions,subject to the regulation enacted by CNSP.
Nonetheless, we understand that theconclusions stated in 2.4.22(b) still holdvalid in relation to the utilisation of theseresources to pursue IFSI.

Canada2.4.24 Furthermore, a transaction made without
financial goals or in order to pursue goals
other than the ones provided in applicableregulation or the by-laws of the Insurance
Undertaking could be barred by SUSEP orother regulators if it has the potential toharm the financial, economic and actuarialbalance of their technical reserves.

United States

China

European Union
FranceJapan

Netherlands

South Africa
United Kingdom

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BRAZILCONTENTSFOREWORDSINTRODUCTION

3.

ASSET OWNERS’ USE OF THEIR POSITION TO ENGAGE IN STEWARDSHIP ACTIVITIES TO SECURESUSTAINABILITY IMPACT

3.1

Brazilian Asset Owners do not have astrong history of stewardship activities 51.
In any case, stewardship shall be exercisedby those who can exercise effective
influence in the managerial decisions of
the investee company, which can be done
through participation in the capital stockor though positive and negative covenants
agreed upon in the context of thesubscription for or purchase of the security
or asset which the Asset Owner owns.

3.2

3.3

201

In 2016, the Association of Capital Market
Investors (Associação de Investidores no
Mercado de Capitais – AMEC) publisheda Code of Principles and Duties ofInstitutional Investors – Stewardship(Código de Princípios e Deveres dos Investidores
Institucionais – Stewardship – AMEC
Stewardship Code), which sets forthseven principles 52 to foster a stewardship
culture among institutional investors
in Brazil. Adhesion to the AMEC
Stewardship Code is seen by the market
as a commitment to adopt best practices
and therefore an Asset Owner could beinterested in adhering thereto in order toimprove its image and reputation in themarket and seize opportunities that could
arise therefrom.
Asset Owners that adhere to the AMEC
Stewardship Code would have a duty toobserve its Principle No. 3, which provides
a recommendation for institutional
investors to integrate ESG factors in theirinvestment process and stewardship
activities, evaluating both their impact onrisks and returns and their contribution to
the sustainable development of the issuersof securities 53. Moreover, pursuant to its
Principle No 1, they would have to state in a

• Other possible activities. Relevant

written document the stewardship activities
to be developed and how the exercise of
these activities will progress, as well as how
the guidelines chosen for the interaction
between institutional investors and theissuers of securities will create value for andprotect the Beneficiaries. Visibility of the
stewardship programme should be provided
to all stakeholders of the Asset Owners, notjust to the Beneficiaries.
3.4

Despite potential benefits, collective
shareholder engagement may raise
legitimate concerns, and uncertainty
in this area is still likely to discouragecollective engagement in practice:

Investors and Asset Owners may also
focus on collaborative actions that do notpose antitrust concerns, especially joint
advocacy initiatives with policymakers,
stakeholders and the competition
authority, such as: joint initiatives todevelop standard investment classification
or measurement tools (provided there
are fair and equal rights to their use);
or exchanging best practice insights on
IFSI (provided the information is notcompetitively sensitive).
3.5• Competition law concerns. In Brazil,

any conduct that has the potential torestrain, distort or in any way harmcompetition may constitute an antitrust
violation, even if such effects are notachieved and regardless of the intentionof the wrongdoer. This include explicit
or tacit agreements between competitors
54
regarding aspects that could have acompetitive effect, such as price-fixing,
division of territories, assignmentof customers, supply restriction or
agreements to exchange competitively
sensitive information 55. In this sense,
arrangements designed to achieve
Sustainability Impact 56 could have acompetitive effect and therefore could
raise concerns of a potential antitrust
violation. However, it is possible that
Asset Owners and Relevant Investors
cooperate to maximise the impact of
their sustainability activities if potential
antitrust risks are neutralised 57- 58.

3.6

3.7

These initiatives shall result in moretransparency and legal certainty for
Relevant Investors and Asset Owners engage
in stewardship activities designed to achieve
positive sustainability outcomes andminimise negative sustainability outcomes.
Accordingly, to comply with the
obligations undertaken by being asignatory of the AMEC StewardshipCode, institutional investors should: (a)implement a stewardship programme;(b) implement mechanisms to manage
conflicts of interest; (c) take ESG factors
into account in their investment processes
and stewardship activities; (d) monitor theissuers of invested securities; (e) be active
and diligent in the exercise of voting
rights; (f) establish collective engagement
criteria; and (g) be transparent as to theirstewardship activities.
The following section considers theextent to which, and on what basis, eachtype of Asset Owner is (a) required or(b) permitted or able to use its position
to influence the activities of investee
enterprises by engaging in stewardship

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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activities designed to achieve positive
sustainability outcomes and minimise
negative sustainability outcomes.
3.8

be discouraged from doing so, especially
if the potential benefits arising fromsuch activities are shared among otherstakeholders and the costs are solely borneby the Pension Funds and/or the Investment
Manager. Cooperation with other Asset
Owners, such as the IPC’s initiative – which
has the full support of the United Nations’Principles for Responsible Investment – andthe Anti-Corruption Action 61 – which is led
the Brazilian local network of the United
Nations’ Global Compact –, is likely to
mitigate such an inhibitor, however no duty
to collaborate arises from the legislation inforce. In this context, adhesion to the AMEC
Stewardship Code is seen by the market
as a commitment to adopt best practices
and therefore a Pension Fund could beinterested in adhering thereto in order toimprove its image and reputation in themarket and seize opportunities that could
arise therefrom.

Pension funds

Legal requirements to engage for Sustainability
Impact3.8.1

Although the latest regulations establishthat Pension Funds should consider
aspects related to the economic,
environmental, social and governancesustainability, as well as they shall be
diligent in monitoring investments andtransparent with their participants,
there are no direct and express legal
provisions that (a) require Pension Funds
to engage in stewardship activities related
to Sustainability Impact nor (b) arise
from the discovery that an investment isgenerating negative Sustainability Impact;see 1.5.1 above on instrumental IFSI.

Legal freedom to engage for Sustainability Impact
3.8.2

3.8.3

202

Although the current laws and regulations
do not create any express obligation
for Pension Funds to actively engage
in stewardship activities to secure
Sustainability Impact, they could engage
in such activities, provided their legal
and regulatory obligations are fulfilled,pursuant to the guidelines set forth intheir investment policies 59. It should behighlighted that, in any case, engaging
in stewardship activities would only bepermissible to the extent that actuarial
obligations of Pension Funds are not put
in jeopardy as a consequence thereof 60.
Nonetheless, actively engaging in
stewardship activities could result in civil
liability for the Pension Funds and/or
their investment decisionmakers if theybreach their fiduciary duties and cause
damage, and, as a consequence, they could

3.8.4

3.9

As a consequence, Pension Funds thatadhere to AMEC Stewardship Code would
have a duty to observe its Principle No.
3, which provides a recommendation for
institutional investors to integrate ESG
factors in their investment processes
and stewardship activities, evaluating
both their impact on risks and returns
and their contribution to the sustainable
development of the issuers of securities 62.
Mutual funds

Legal requirements to engage for Sustainability
Impact3.9.1

Unless otherwise provided in the
by-laws of the investment fund or in
the by-laws (estatuto social) or articles
of association (contrato social) of theInvestment Manager, no direct legal
duties (a) require investment funds toengage in stewardship activities related

to Sustainability Impact nor (b) arise
from the discovery that an investment isgenerating negative Sustainability Impact.
3.9.2

3.9.3

As an exception to the rule describedabove, investment funds in the formof FIPs are required by applicableregulation to take part in their investees’
decision-making process, with effective
influence on their strategic policy andmanagement63. However, such duty is notdirectly connected to the requirement to(a) engage in stewardship activities; or (b)generate positive and/or reduce negative
Sustainability Impact to any extent.
However, if the lack of engagement were to
result in a direct loss for the FIP’s investors(quotaholders), the Investment Manager
would have a duty to act to prevent such
avoidable harm to the quotaholders byactively engaging in stewardship activities,
which could potentially be connected to
Sustainability Impact (instrumental IFSI,
see also 1.5.1 above)
Also, it should be noted that, dependingon the type of investment fund and theprovisions of the by-laws, any charges
or expenses related to engagement instewardship activities would have to beborne by the Investment Manager and/or
fiduciary administrator thereof.

Legal freedom to engage for Sustainability Impact
3.9.4

Investment funds’ Investment Managers
would generally only be able to actively
engage in stewardship activities to secure
Sustainability Impact if such powers areprovided for in the fund’s by-laws (which
would be characterised as an ultimate
ends IFSI strategy) or granted thereto
by the agreement through which it was
engaged. That said, an argument could
be made that IFSI could be pursued
where these documents are silent if (a)ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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there is wording related to the pursuit oflong term returns; (b) a reasonable link
could be made between the long-term
profitability and likelihood of success ofthe stewardship activities to be performed;and (c) the cost of engaging in suchactivities is perceived to be smaller than
the increase in long-term profitability
that they would generate, weighted by
the likelihood of success 64. It should be
noted, however, that there is no clear
definition for the time frame in which thisassessment should be carried out.
3.9.5

3.9.6

3.9.7

203

Additionally, there would be no
impediments as to the engagement ofan Investment Manager that has a houseapproach of pursuing sustainability
outcomes in its engagement activity,
irrespective of the by-laws, although
the Investment Manager must not carryout any activity not permitted by theinvestment policy.
Moreover, investment funds that do
not invest the majority portion of theirresources in equity securities, such as
FIDCs, could engage in stewardship
activities. This could be done, forinstance, by conditioning the purchaseof receivables to the execution of anagreement by means of which the FIDC
would be granted the power to influence
the assignor’s or debtor’s activities
regarding Sustainability Impact.
Passively managed funds, typically fixedincome investment funds referenced in a
specific fixed-income index or ETF would
likely face practical difficulties regarding
the costs associated with stewardship
activities due to the low management fees
they usually charge.

3.10

Insurance undertakings

Legal requirements to engage for Sustainability
Impact3.10.1 No direct legal duties (a) require Insurance
Undertakings to engage in stewardship
activities related to Sustainability Impactnor (b) arise from the discovery thatan investment is generating negative
Sustainability Impact, unless otherwise
provided in the by-laws of the Insurance
Undertakings. However, if such activities
were to support the financial return goal,
there might be circumstances where IFSI
is indeed required (see 1.5.1 above on
instrumental IFSI).
Legal freedom to engage for Sustainability Impact
3.10.2 Insurance Undertakings are permitted
to engage in stewardship activities tosecure Sustainability Impact, as long as
their actuarial obligations and regulatory
duties are not put in jeopardy as aconsequence thereof 65.
3.10.3 If Insurance Undertakings are publicly
held corporations, mandatory disclosureof environmental data, as described in
2.4.20 above, could nudge their managers
towards adopting strategies to pursue
IFSI, including engaging to secure
Sustainability Impact, in case not doing
so could lead them to be less attractive toinvestors considering their competitors.
However, the costs of such engagement
could be an inhibitor, since they could
outweigh any foreseeable return achievedby the engagement itself.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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4.

ASSET OWNERS’ ENGAGEMENT IN PUBLIC POLICY WORK TO SECURE SUSTAINABILITY IMPACT

4.1

The following section considers theextent to which, and on what basis, eachtype of Asset Owner is (a) required or (b)permitted or able to use its position to
engage in public policy work designed toachieve positive sustainability outcomesand minimise negative sustainability
outcomes, for example, where these are
relevant to the value of portfolio assets.

4.2

4.3

204

It is important to note that Brazil lacks aspecific regulatory regime for lobbying.
Nonetheless, the Brazilian political system
is an open field for engagement in public
policy work to secure Sustainability
Impact, offering several fields in which toengage: lobbying could be engaged withthe legislative branch and/or the executive
branch (whereas the latter includes not
only the heads of office but also ministries,
secretaries, regulatory agencies such as
the CVM, inter-ministerial or inter-agency
working groups), and both branches may beengaged in federal, state and/or municipal
levels. Moreover, most parts of the debatesat the Brazilian National Congress are open
to civil society participation.
All Asset Owners described in this annex
have the legal freedom to cooperate
among themselves in policy activities, andalthough that might be recommendable
in order to address systemic sustainability
issues that may negatively affect theperformance of their investment portfolio,
no specific duty to do so arises fromthe legislation in force (see 1.5.1 on
instrumental IFSI).

4.4

Pension funds

4.4.1

Funds are not expressly required by law or
regulation to engage in policy discussions
and/or lobbying with policymakers.

4.4.2

There are no rules preventing engagementin policy discussions and/or lobbying.
Therefore, where the by-laws are silent on
the matter, Pension Funds could potentiallyengage in such activities as long as it does
not prejudice their compliance with theapplicable laws and regulations and theiractuarial obligations 66.

4.4.3

4.4.4

It should be noted that in some cases any
expenses indirectly related to lobbying
would have to be borne exclusively by thePension Funds, which act as an inhibitor to
engaging in such activities, since Pension
Funds are non-profit-making entities andonly manage third parties’ resources.
Nonetheless, a Pension Fund may act
together with other investors in an
investment fund in which it holds alarge enough portion of quotas to engage
in policy discussions and/or lobbying
through the fund, with the related
expense being charged to the fund, its
fiduciary administrator or its Investment
Manager, pursuant to 4.5.2 below, or it
could act through interest groups who
would then bear such expenses.

4.4.5

Mutual funds

4.4.6

Investment funds are not expressly
required by law or regulation to engage inpublic policy discussions and/or lobbying
with policymakers.

4.4.7

There are no rules preventing investment
funds from engaging in policy discussions
and/or lobbying. Nonetheless, current
regulation provides that any expenses notprovided for in the by-laws as a charge
payable by the fund shall be borne by thefiduciary administrator or the Investment
Manager, as applicable, unless otherwise
resolved by the quotaholders’ general
meeting. Hence, expenses related toengagement in policy discussion and/or
lobbying would have to be borne exclusively
by the fiduciary administrator or theInvestment Manager and they might, forthis reason, be unwilling to do so.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXES

4.5

Insurance undertakings

4.5.1

Insurance Undertakings are not expressly
required by law or regulation to engage inpolicy discussions and/or lobbying
with policymakers.

JURISDICTION REPORTS

Usually, any expenses related to lobbying
would have to be borne by the Insurance
Undertaking if this is in accordance with its
standard practices and compliance policies.

CanadaNonetheless, these corporations may
act together with other investors in an
investment fund in which they together
have a large enough portion of the issued
quotas, or act through professional
associations of Insurance Undertakings,
to engage in policy discussions and/or
lobbying through this fund, with therelated expense being charged to thefund, to its fiduciary administrator toits portfolio management or to relevant
associations, pursuant to 4.5.2 above 67.

France

4.5.2

4.5.3

Australia
BrazilChina

European UnionJapan

Netherlands

South Africa
United Kingdom
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5.

ESTABLISHING NEW FUNDS TO INVEST FOR SUSTAINABILITY IMPACT AND AMENDING THE
TERMS OF EXISTING ONES

5.1

The following section considers the extent
to which it is possible for an Asset Owner
to set up a fund, an insurance policy orother product with the express objectiveof pursuing IFSI.

Private autonomy
5.1.1

The by-laws or other applicable relevant
documents 68 of the Asset Owners
themselves could provide that (a) only an
Investment Manager that seeks or thathas provisions in its by-laws or articles
of association regarding Sustainability
Impact or that has publicly committed
to address Sustainability Impact goals
may be engaged to manage the portfolioof the Asset Owner; or that (b) the Asset
Owner would only engage in transactions
with counterparties that observe ESG
principles and/or engage in activities
aimed at reducing negative and/or
increasing positive Sustainability Impacts.
The validity of any such provision should
be strengthened by the Declaration of
Economic Freedom Rights 69, which
establishes rules and principles to assure
protection for free enterprise and the free
exercise of economic activity.

Potential practical difficulties with pursuing IFSI
5.1.2

205

First of all, it is worth mentioning thatinvestment decision-makers may face thetypical practical difficulties associatedwith IFSI, such as the lack of disclosure
requirements regarding the social andeconomic impact of the portfolios they
manage or of investees themselves
70; for that reason, the investment
decisionmakers would probably require
the investee to adopt levels of governancerelated to Sustainability Impact thatit has never previously had in order
to be eligible for the investment of an
Asset Owner’s fund that invests for
Sustainability Impact.
5.1.3

5.1.4

5.2

Additionally, one of the greatest
challenges to sustainable investing is
to change the general misperceptionof investors that IFSI does not lead togood financial returns 71. In this context,
academic and industry research have beenchanging such perception, since theirfindings show that (a) over the long-term,
the risk-return ratio of projects focused on
Sustainability Impact is not significantly
different from projects without such
focus; and (b) Sustainability Impactfocused projects offer potential additionalrisk protection to their investors 72.
The increasing awareness about this topic islikely to increase investors’ desire to pursue
IFSI, which, in its turn, positively reinforces
the nudge for Asset Owners to adopt
strategies focused on Sustainability Impact
or that, to some extent, take Sustainability
Impact-related issues into account.
Pension funds

Establishing a new pension fund or pension plan andamendment of an existing pension fund or pension plan
5.2.1

It is important to highlight that Pension
Funds have a limited scope of activity
and are not allowed to engage in any
sort of transaction other than manage
pension plans. Failure to comply with thisrequirement subjects the managers of aPension Fund subject to administrative
penalties, according to the applicable rules.

5.2.2

5.2.3

5.2.4

Since the pension plans are structured ina capitalisation system, the investment
activities carried out by Pension Plans areunderstood as an essential activity to ensure
its ultimately and exclusive purpose whichis to pay benefits for the Beneficiaries.
There are no provisions in Brazilian law
that would prevent a Pension Fund fromstating in its by-laws or in the by-laws of
any of the pension plans operated by it –subject to the PREVIC’s approval – thatthe portfolio should be managed in such a
way as to try to achieve the most positive
Sustainability Impact possible, although
doing so would be unusual. For instance,
it is possible for a Pension Fund to include
in the investment policies of its pension
plans the objective of generating welfare
to its Beneficiaries 73. Notwithstanding
this, the investment policies could neverprioritise Sustainability Impact overfinancial return, since Pension Funds haveactuarial and financial duties to meet.
Having said that, the content of the by-lawsof any pension fund (estatuto) and of the
by-laws of the pension plans (regulamento)
managed by it, as well as any amendments
to such documents, must be approved by
PREVIC to be effective. Subject to PREVIC’sapproval of the content of the amended
and restated by-laws, the competent bodywithin the Pension Fund – generally thedeliberative council (analogous to a boardof directors) – is able to amend the existingby-laws, with a statement by the legal
representative of the Pension Fund ensuringthat prior notice of the amendment wasgiven to the participants and sponsors of

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

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the plan 74- 75. When amending by-laws,
the Pension Funds must present to PREVIC
formal consent from its sponsors.
5.2.5

5.2.6

5.2.7

206

When establishing their investment
policies, Pension Funds must consider thefollowing aspects: (a) diversification rules
regarding financial assets categories andissuer concentration limits; (b) reference
indexes and actuarial rates; (c) objectivesof using derivatives; (d) guidelines forobserving ESG principles per industry
invested in 76; and (e) information
pertaining to (i) pricing methodology offinancial assets in its portfolio, (ii) risk
management, (iii) assessment and selectionof service providers, (iv) monitoring of
the risk-return ratio of the portfolio, (v)limitation of the liability of each individual
analysing, assessing, managing andsupporting investment decisions, and (vi)mitigation of potential conflicts of interestin the decision-making process 77.

5.2.8

Duties on those designing, manufacturing andproviding pensions funds
5.2.9

5.3

5.3.3

5.3.1

5.3.4

There are no legal requirements toobserve Sustainability Impact whenorganising or amending the by-laws of aPension Fund.
Mutual funds

5.3.2

There are no provisions in Brazilian
law that would prevent an investment
fund from stating in its by-laws thatits portfolio should be managed by
the Investment Manager in a way to
pursue Sustainability Impact as its soleor main objective (ultimate-ends IFSI)
78. As described in 2.3.3 above, if suchprovisions are stated in the by-laws, theInvestment Manager, in pursuing thefund’s investment policy and taking into
consideration the best interests of theinvestors, must comply with them.
It is important to note that the analysisof the actual Sustainability Impact of
an investment would necessarily be expost, meaning that compliance with arequirement to allocate a certain amountof assets in projects that yield positive
Sustainability Impact could thus besubsequently called into question.

Additionally, it is worth noting that thefiduciary administrator, Investment
Manager and any other service provider
must comply with all the provisionsof current law and regulation, theinvestment fund’s by-laws and performtheir activities with transparency,
diligence and loyalty towards their clients.

Amending an existing mutual fundEstablishing a new mutual fund

Additionally, Pension Funds’ investment
policies must be annually reviewed,
pursuant to 2.2.7 above.
It is important to note that even though
the legal duties and powers of Pension
Funds’ investment decisionmakers do not
permit or allow sufficient flexibility fora Pension Fund to have an objective for a
portfolio that would involve IFSI rather
than having an investment objective toachieve a particular investment return,there are no impediments regarding theamendment of the Pension Fund’s by-lawsin order to provide Sustainability Impact
as a goal of the Pension Fund, pursuant to
5.2.4 above.

If the Pension Fund has fulfilled its
actuarial and financial obligations, its
investment decisionmakers could takesteps to make the competent governancebody of the Pension Fund approve
amendments to the by-laws of therelevant pension plan (regulamento) so that
Sustainability Impact goals are expressly
provided as one of the objectives thereof.

To amend an investment fund’s by-laws
to establish an IFSI investment policy, aresolution of the quotaholders 79 gathered
at a general meeting is required. The
general meeting may be convened by theadministrator or quotaholders representing
at least five per cent of the fund’scommitted capital. It should be noted that,investment funds with a wide dispersionof ownership may find convening
quotaholders’ general meetings impractical.

Duties on those designing, manufacturing andproviding mutual funds
5.3.5

5.4

There are no legal requirements toobserve sustainability impact whenestablishing or amending the by-laws of
an investment fund.
Insurance products

Establishing a new insurance product5.4.1

Insurance companies must prioritise
financial security to the Beneficiaries
related to the insurance policy, as
described in 2.4 80, meaning that they shallmanage their technical reserves to preventthe risk of becoming insolvent or in any
way unable to perform their financial
duties. Technical reserves are created withthe specific purpose of ensuring the abilityof the insurance company to provide

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

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5.4.2

5.4.3

5.4.4

5.4.5

payments or indemnities under the policy.

Amending an existing policy

It should also be noted that Brazilian
insurance products are conceived toprotect the insurable interests of theirinsured parties and beneficiaries,
thus preventing any provision that isinconsistent with such protection.

5.4.6

However, there are no provisions in
Brazilian law that would prevent an
insurance company from managing
their insurance products reserves’ assets
to invest with the goal of achieving
positive Sustainability Impact to theextent considered likely to reduce risks toreserves in the long term.

Duties on those designing, manufacturing andproviding life insurance products

Just as Pension funds, insurancecompanies have a limited scope of activity
and are not allowed to engage in any sortof transaction that is not comprised insaid scope (ie manage insurance products).
Failure to comply with this requirement
subjects the company to administrative
penalties, according to the insurance andreinsurance regulations.
Since the investment activity may beunderstood as an essential activity toensure its ultimately and exclusive
purpose which is to pay insurance
indemnification for the beneficiaries
appointed in the insurance policies, froman instrumental IFSI perspective, it would
be possible for insurance companies toinvest with the goal of achieving positive
Sustainability Impact to the extent
considered likely to reduce risks toreserves in the long term.

5.4.7

As previously stated in 5.4.2 above, expectfor open pension plan and life insurancewith survival coverage, insurance policies
only contain provisions regarding insurance
coverage and do not provide for theinvestments made by the insurance company.

There are no legal requirements toobserve Sustainability Impact whenestablishing or amending the by-laws ofan Insurance Undertaking.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

207

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6.

INVESTMENT MANAGERS’ DUTIES TO INVEST FOR SUSTAINABILITY IMPACT

6.1

This section considers the extent to which,and in what circumstances, an Investment
Manager is (a) legally required or (b) legallypermitted to pursue IFSI on behalf of an
Asset Owner or otherwise, in each of thethree ways contemplated in sections 2-4.

6.1.1

6.1.2

208

Investment Managers need to be
duly authorised by the CVM before
rendering portfolio management services
professionally. The applicable regulation
enacted by the CVM mandates that they
always act ethically, in good faith andwith transparency and loyalty to the
Asset Owner, pursuant to the investment
objectives of the Asset Owner and thoseof the Beneficiaries thereof, with thediligence observed by an active andhonest person while managing his/herown business. Investment Managers also
must avoid practices that may harm thefiduciary relation with the Asset Owner.
Typically, an Investment Manager’s
investment duties and powers areprovided for in: (a) the investment
management agreement entered into
between itself and the Asset Owner 81; and(b) the regulations applicable, which arehighly dependable on the Asset Owner’s
regulators 82, as will be further explainedin 6.2 and 6.3 below. The investment
management agreement, on its turn,
typically has provisions regarding: (a) theinvestment objective(s) based on which
the Investment Manager’s performance
will be assessed (and performance-relatedcompensation earned, if applicable); (b)the types of assets that may compose theportfolio, as well as the minimum andmaximum concentration limits per issuer
and per asset class 83; (c) any investment
restrictions 84; (d) any investment strategy

specified by the Asset Owner; and (e)indemnity clauses against the Asset Owneror its legal representative.
6.2

the by-laws of a certain fund provide forthe need to take Sustainability Impact
factors into account when making an
investment or divestment decision
regarding the investment fund’s portfolio,
the Investment Manager is required toobserve said criteria (ultimate ends IFSI)
and could be held liable for not doing so.

Legal obligations with respect to
Sustainability Impact

Powers of investment and divestment
Pension funds
6.2.1

Where its mandate is silent regarding
Sustainability Impact, the Investment
Manager has no general obligation nor isunder any duty to pursue IFSI regarding
both instrumental IFSI or ultimate-ends
IFSI; however, where IFSI serves as a mean
to reach a financial return goal, there
might be circumstances in which there
is an obligation to consider sustainability
factors and eventually act accordingly (see1.5.1 on instrumental IFSI)

6.2.5

Mutual funds
6.2.2

6.2.3

6.2.4

In an investment fund, the Investment
Manager holds all powers related to theinvestment and divestment of assets, aswell as exercises at its discretion – unlessprovided for otherwise in the by-laws – allrights granted by the assets in the fund’s
portfolio (such as voting rights arisingfrom ownership of a share) 85.
Brazilian legislation in force does not
set forth which objectives investment
funds must have, nor does it require
investment funds to have non-financial
goals or to take non-financial objectives
into account, nor even to consider positive
Sustainability Impact as a by-product of
the investments made.
On the other hand, applicable regulation
states that it is part of the Investment
Manager’s duties to comply with theinvestment fund’s by-laws. Therefore, if

6.2.6

Moreover, unless otherwise specified
in the fund’s by-laws, the Investment
Manager is not under any duty to (a)ascertain the investors’ objectives
regarding sustainability objectives, giventhat the Investment Manager is solely
responsible for the portfolio management
decisions on behalf of the Asset Ownerand cannot be liable for not assessing
Beneficiaries’ individual views or objectives
on Sustainability Impact, or (b) address
long-term systemic risks (eg those related
to climate change) which, were they tomaterialise, could damage the long-term
financial interests of the quotaholders.
Furthermore, legislation and regulation inforce do not require Investment Managers
or fiduciary administrators to ascertain
their clients’ sustainability objectives.

Insurance undertakings
6.2.7

Although unusual, Insurance
Undertakings could engage an Investment
Manager to manage their assets. Where its
mandate is silent regarding Sustainability
Impact, the Investment Manager has no
obligation nor is under any duty to invest
for Sustainability Impact.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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Engagement to achieve Sustainability Impact

6.3.2

Pension funds
6.2.8

As mentioned in 6.2.1 above, theInvestment Manager would be limited
in its engagement activities by the termsof the pension plan’s by-laws and by
the terms of the investment agreement
through which it was engaged.

Mutual funds
6.2.9

Where the by-laws of a certain fundprovide for the need to engage in
stewardship activities and to takeSustainability Impact factors into accountwhen doing so, the Investment Manager
is legally required to observe said criteria
and could be held liable for not doing so.

Insurance undertakings
6.2.10 There is no legal or regulatory obligation
or requirement for Investment Managers
of Insurance Undertakings to pursue
IFSI, either by utilising their investment
and divestment powers or by engaging in
stewardship activities.
Public policy work to achieve Sustainability Impact
6.2.11 Asset Owners are not required to engage
in policy discussions and/or lobbying
with policymakers to achieve
Sustainability Impact.
6.3

Legal freedom to Invest for
Sustainability Impact

6.3.1

The Investment Manager’s freedom tomanage the portfolio of an Asset Owner
towards generating positive or minimisingnegative Sustainability Impact shallalways be limited to the terms of theinvestment management agreement
through which it was engaged.

209

6.3.3

However, even where the investment
agreement through which the Investment
Manager was engaged and the bylaws of the investment fund or of thePension Fund’s pension plan are silent
regarding Sustainability Impact, theInvestment Manager would, under certain
circumstances and on reasonable grounds,
be able to Invest for Sustainability Impact –although with little leeway 86. Additionally,an Investment Manager could have
Sustainability Impact goals provided for in
its own by-laws or articles of association
87, which could set objectives for thecompany or principles which its officers
and directors should follow under theirtenures. Where those are incompatible
with the mandate given by the Asset
Owner, the mandate shall prevail.
If an Investment Manager intends toactively engage in stewardship activities, it
should prove to the CVM that it maintains
appropriate technical and humanresources to do so 88.

Mutual funds
6.3.6

6.3.7

6.3.8

Powers of investment and divestment
Pension funds
6.3.4

6.3.5

Where the investment agreement throughwhich the Investment Manager was
engaged and the by-laws of the investment
fund are silent regarding Sustainability
Impact, the Investment Manager could
pursue IFSI as stated in 2.2.15 above,
subject to the provisions of 2.2.16 above;see also 1.5.1 above on instrumental IFSI.
The Investment Manager’s decisions
should follow the provisions of thePension Fund’s pension plan’s by-laws andits actions must be in accordance with thepowers granted to it in the investment
management agreement.

The Investment Manager’s decisions must
follow the provisions of the investment
fund’s by-laws and its actions must
be in accordance with the investment
management agreement. This meansthat Investment Managers could fully
use their investment and divestment
powers to pursue IFSI if the by-laws set
that as a target for the investment fund’sinvestment policy.
Where the investment agreement bywhich the Investment Manager was
engaged and the by-laws of the investment
fund are silent regarding Sustainability
Impact, the Investment Manager would,
under certain circumstances and on
reasonable grounds, be able to invest for
Sustainability Impact – although withlittle leeway, as indicated in 2.3.11 above.
Furthermore, it is common for Investment
Managers to provide in their code of ethics
that the investment funds they manage
shall not invest in certain industries,
such as tobacco, gambling, arms andammunitions, atomic energy or industries
that depend on supplies or manufacturing
processes that heavily generate greenhousegases or other harmful by-products.

Insurance undertakings
6.3.9

Investment Managers only have thepowers granted thereto by the Insurance
Undertaking and they may invest theirfunds in accordance with the regulatory
restrictions applicable to the technicalreserves and provisions, when the casemay be.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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Engagement to achieve Sustainability Impact
6.3.10 Since stewardship activities are less likely
to affect the composition of an investment
portfolio, it could be argued that there ismore flexibility to pursue Sustainability
Impact through stewardship activities than
through Sustainability Impact investments.
However, as stated in 4.5.2 above, it should
be noted that for most investment funds,
the costs of such engagement would
likely have to be borne exclusively by thefiduciary administrator or the Investment
Manager, which could act as an inhibitor
for engaging in such activities.
6.3.11 Public policy work to achieve Sustainability
Impact6.3.12 Asset Owners are not required by law or
regulation to engage in public policy workto achieve Sustainability Impact, althoughthat may be recommendable, as statedin 4.3 89.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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REFERENCES

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7.

LEGAL LIABILITY TO THIRD PARTIES FOR THE NEGATIVE SUSTAINABILITY IMPACT OF
ENTERPRISES IN WHICH PORTFOLIOS ARE INVESTED

7.1

This section considers the extent to which,regardless of the legal rules under which itis required to operate and its constitution,
an Asset Owner could be legally liable tothird parties for the negative Sustainability
Impact of enterprises in which it invests,
and whether an Investment Manager could
also be liable because of its role in assisting
the Asset Owner to invest in the relevant
enterprise and steward its investment.

7.1.1

7.2

7.2.3

7.2.4

The analyses in 7.2 and 7.3 below do notcover the liability of an Asset Owner oran Investment Manager, respectively, totheir Beneficiaries 90 nor the liability of aninvestee company to an Asset Owner 91.
Asset Owners

7.2.2

211

Civil liability in Brazil depends, in general,on the establishment of causation – ie one
shall only be liable to third parties wherea causal relationship can be establishedbetween its conduct and the damages
incurred by the third party. Furthermore,civil liability is generally subjective
92, which does not prevent an Asset
Owner from having strict or subjective
contractual liability, if such a contract
or an agreement has been entered into
between itself and a third party 93.
As a rule, the civil liability of an Asset
Owner in relation to its investees islimited to the capital it committed
thereto. However, under certain
circumstances, an Asset Owner could
be called upon to make additional
contributions to enable the investees tomeet their obligations 94.

for tort liability requires intent or
negligence of the wrongdoer, in whichcase Brazilian law allows the injured party(or a representative of a class or groupof injured parties, such as the publicprosecutor’s office) to pursue civil liability
claims to remedy the harm suffered.
There are three cumulative elements
required for the establishment of tort
liability: (a) the practice of an unlawful
conduct (act or omission – in this case,the enterprise’s negligent omission); (b)damage to the injured party (in this case,the judge deemed the mentioned working
conditions impacted society as a whole);and (c) direct causal link between theunlawful act and the damage (in this case,the causal link was defined due to the
supply chain).

Subjective civil liability

Civil liability
7.2.1

As the examples below show, although
the possibility of an Asset Owner being
held liable for negative Sustainability
Impact caused by its investments cannot
be fully discarded, the risks of civil
liability being imposed in practice may be
regarded as remote.

7.2.5

Some precedents in Brazilian case law
suggest that the performance of economic
activities without due observation of
the social function 95 may result in
the imposition of liabilities towards
the general community, in the case ofnegative social impacts, such as humanrights violations. Considering thecollective essence of the damages to thegeneral community, these can be claimed,among others, by the state, the publicprosecutor’s office, the public defender’s
office or non-profit organisations throughan action claiming liability for moral ormaterial damages to collective or diffuse
interests 96, according to Law No. 7,347, of
24 July 1985.
For example, there is a precedent of
tort liability holding a company that
outsourced part of its production chain
liable for collective moral damages,
because one of its suppliers kept
employees working under conditions
analogous to slavery 97. The passive
behaviour of the contracting company
was considered ‘harmful to the economic andfinancial order, especially to the fundamentalsof (...) the social function of ownership and the
reduction of regional and social inequalities’,
thus, negligent and unlawful, triggering
tort liability. As a rule, cause of action

7.2.6

Even though underlying general principles
of economic activity have not been
confronted in relation to the role playedby Asset Owners, they could be applied– although this is unlikely – to holdthem liable for negative Sustainability
Impacts incurred by the enterprises they
have funded, if their acts can be deemedunlawful (eg due to an omission in at least
not minimising negative Sustainability
Impacts of the investees), and other tort
liability requirements are verified, as
explained above. It would be importantto have clearer rules to establish theliabilities of investors in such cases.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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Strict civil liability
7.2.7

From a civil perspective, the Brazilian
National Environmental Policy (Política
Nacional do Meio Ambiente) 98 establishes
that liability for environmental damages

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is strict 99, meaning that the fault of thepolluter does not need to be proven,assuming that the chain of causation
between the polluting activity performedby the polluter and the environmental
damage is verified. For this reason,
any individual or company, publicly
or privately held, directly or indirectly
responsible for any environmental
degradation is considered a polluter,and hence is subject to environmental
civil liabilities. This means that theenvironmental damage must be
duly addressed by remediation orindemnification. Under this very broad‘indirect polluter’ notion, civil liability
may be, in theory, extended to any party
involved in the activity that was the causeof environmental degradation.
7.2.8

212

When confronted with the interpretationof the indirect polluter concept, the STJ
held 100 that any party that (a) fails toprevent, or acts with indifference to,polluting activities; (b) fails to reportsuch activities to authorities; (c) finances
those that carry out such activities; or (d)benefits from such activities, is deemed
to be an indirect polluter, thereby being
encompassed by the pollution chain of
causality and subject to joint and several
liability for environmental degradation.
In other relevant case law 101, the STJ
clarified that the indirect polluter concept
encompasses all those who have a duty toprevent an environmental degradation andfail to do so, profiting, even if indirectly,
from third party actions that lead toenvironmental harm. This far-reaching
concept could, in theory, comprise all Asset
Owners discussed herein, which contributeto companies or projects that result inenvironmental damages.

7.2.9

Thus, the decisions should be interpreted
as indicating the potential inclinationof the STJ in relation to the concept of‘indirect polluter’. The earliest decision was
rendered in 2007 (published in 2009) andthere has not been any concrete case thatapplied this theory and held an investor
liable for environmental damages.

7.2.10 Nonetheless, it is important to mention
that the decisions presented hereinabove
were not made in relation to the liabilityof the Asset Owners referred in this annex– most of the related case law consists ofjudicial discussions involving financial
institutions. Moreover, even in such cases
there is not a consensus on the limit ofliability regarding indirect polluters, giventhat in other STJ decisions the indirect
polluter concept was applied in a more
restrictive manner.
Criminal liability
7.2.11 All criminal liability in Brazil is
personal and subjective – ie it requiresthat causation is established between
the conduct of the defendant and thecrime – and requires proof beyond
reasonable doubt. As a general rule, it is
only applicable to individuals – the sole
exception being environmental crimes,
for which legal entities can also be held
criminally liable.
7.2.12 Law No. 9,605, of 12 February 1998, which
establishes Brazilian environmental
crimes and administrative sanctions,
imposes criminal and administrative
sanctions on individuals and legal
entities whose conduct and activities
caused environmental damage. In Brazil,
individuals (including managers andofficers) or legal entities that commit acriminal offence against the environment
can be punished with sanctions that

range from fines to imprisonment(individuals) or fines to dissolution (legal
entities). In this sense, if an Asset Ownercommands the legal entity to take anaction (or omission) unlawfully causing(or potentially causing) harm to theenvironment, it or its managers may becriminal liable.
7.2.13 Law No. 9,605, of 12 February 1998, allows
for the corporate veil should be lifted as alast resort when necessary to compensate
for environmental damage caused by alegal entity, which presents a potential
risk for Asset Owners 102.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

Administrative liability and other risks
7.2.14 Administrative sanctions could also
arise from a breach of the Asset Owners
contractual or fiduciary duties, in casethe by-laws of the Asset Owner providethat one of its objectives is to mitigate andminimise negative Sustainability Impact
and the Investment Manager does not takemeasures within its capabilities to do so.
7.2.15 Administrative liability is enforcedby administrative entities only
(independently of the judiciary), mainly
by environmental agencies, throughthe application of the administrative
sanctions, such as fines, partial or totalsuspension of activities, forfeiture or
restriction of tax incentives or benefits,
and forfeiture or suspension of credit
lines made available by official credit
establishments, among others, which areautomatically enforceable.
7.2.16 Sectorial administrative liability isalso applicable, since Pension Funds,
investment funds 103 and Insurance
Undertakings are supervised entities,
respectively, by PREVIC, the CVM and
SUSEP. Administrative liability of an Asset
Owner or a manager thereof 104 shall only

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arise out of an any act it or they may
have performed against the applicablelaws and regulations, including breachof contractual obligations set forth in therelevant documents 105.
7.2.17 The sanctions imposed by PREVIC 106, theCVM 107 and SUSEP 108 can range fromwarnings and fines to the suspension ordisqualification of the Asset Owner and/or its managers to perform the activities
to which they have been authorised toperform or, in more severe cases, any
activities for Pension Funds, Insurance
Undertakings and/or other insurancerelated entities, financial institutions
and public service for a certain period.
Administrative sanctions may also include
a prohibition to enter into a public sector
contract, as applicable.
7.2.18 Additionally, where an Insurance
Undertaking is publicly held, theinvestor relations officer could be held
administratively liable before the CVM
in case he or she fails to disclose amaterial act or fact (which, dependingon the circumstances, may be related to
Sustainability Impact).
7.3

Investment Managers

7.3.1

Brazil’s investment management industry
is relatively incipient when it comes to
producing a body of legal precedents
created by judicial decisions, although
the Brazilian capital market has grownconsiderably in recent years. Therefore,
conflicts tend to be discussed and resolved
at the administrative level.

213

Civil liability
7.3.2

7.3.3

As a rule, Investment Managers cannot beliable based on the poor performance ofinvestments. However, if there has beenany (a) commission of a crime or wilful
misconduct, (b) breach of the obligations
undertaken by the Investment Manager inthe by-laws or in any agreement enteredinto with the Asset Owner, and/or (c)fraudulent performance or performance
involving serious breach of the Investment
Manager’s obligations, it may be liabletowards third parties.
Moreover, an Investment Manager
could be held liable due to its role inassisting the Asset Owner that caused
a negative Sustainability Impact under
the abovementioned notion of “indirect
polluter”, as a party that is indirectly
involved in the activity that caused
environmental degradation 109. In this
scenario, an Investment Manager could
also be liable towards the generalcommunity 110.

7.3.6

Administrative liability and other risks
7.3.7

Criminal liability
7.3.4

As stated in 7.2.11 above, only individuals
are subject to criminal liability, except incase of crimes against the environment.

7.3.5

Criminal liability in Brazil is personal andsubjective – ie it requires that causation
is established between the conduct of theoffender and the crime – and requires
evidence beyond reasonable doubt.
Authorities may press criminal charges
against any individual acting either
wilfully or negligently (the latter only as
expressly provided by law) to commit orconspiring to commit –either directly or
indirectly – a criminal offence.

Whenever individuals do not commit
the crime themselves but somehow
contribute to it, criminal liability canarise from assistance or intellectual or
direct participation in a crime, including
by not acting to avoid a crime in certain
cases. Thus, Investment Managers’
officers, directors, representatives, agents,
or employees involved with a criminal
enterprise may also be subject to criminal
prosecution to the extent of their personal
contribution to the offense 111.

7.3.8

Investment Managers and their officer(s)liable for the activity in question will
have administrative liability for all
damages and losses imposed on investors
and third-parties resulting from theirwilful misconduct or fault by meansof negligence 112 and arising out of any
act they may have performed against
the applicable laws and regulations
113
and the by-laws, pursuant to Law
No. 6,385, of 7 December 1976, whichgovern the Brazilian capital markets.
Members of investment committees thatare responsible for making investment
or divestment decisions and for otheractivities typical of an Investment
Manager share the same liability as those.
In addition, in case of settlement of an
administrative proceeding, the CVM
may require those facing charges tocompensate investors for any losses they
may have suffered in connection withthe violation of CVM regulation by thefiduciary administrator or service providerof an investment fund – including theInvestment Manager.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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7.3.9

ACKNOWLEDGEMENTS

Furthermore, an Investment Manager will
also be subject to penalties imposed by
ANBIMA once it adheres to the ANBIMA’s
self-regulatory rules for any breaches ofthe provisions stated in said rules of bestpractices, among which there is a duty to
act with loyalty to the client.

A. INVESTING FORSUSTAINABILITY IMPACT

7.3.10 In these contexts, an Investment Manager
could be held administratively liable only
where the by-laws clearly mandated some
sort of consideration of Sustainability
Impact which was not fulfilled 114.

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSI

7.3.11 Also, it should be noted that, aside
from traditional litigation risks,
there is a current trend of the largest
institutional investors engaging ininternal investigations regarding theircontributions made to investment funds
and the management of such investments
by the investment fund’s Investment
Manager. These investigations may result
in lawsuits or administrative proceedings
involving the CVM and/or the Central
Bank of Brazil in case an agreement is notreached between the parties.

EXECUTIVE SUMMARY

C. AREAS FOR LEGAL REFORM

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8.

THE GROWING IMPORTANCE OF TAKING ACCOUNT OF ESG AND SUSTAINABILITY FACTORSWHERE THESE ARE ‘FINANCIALLY MATERIAL’

8.1

It has become increasingly important for
Asset Owners and their managers to take
ESG and sustainability factors into accountin managing portfolios because of the way
in which they could be material to achieving
the financial investment objectives of
the relevant Asset Owner or manager inaccordance with their legal duties. The main
reasons are summarised below.

8.1.1

8.1.2

8.1.3

8.1.4

215

amassed 27 signatories in its three
years of existence 118, including some of
the largest pension funds in Brazil 119,BNDES Participações S.A. 120, three of thecountry’s largest banks 121 and other major
national and international Asset Owners.
However, according to the ANBIMA ESG
guide, in a survey made by ANBIMA before
the publication of the guide, 66 per centof respondents said they have no internal
structure assessing the Sustainability
Impact of their portfolios and 51 per centsaid they have no formalised responsible
investment policy; whereas of those
who do integrate ESG-based criteria for
selecting assets to comprise a portfolio,
only a third are using strategies such asactive engagement and integrating thatanalysis in the valuation of the companies
they invest in, while most still rely on
more basic strategies such as negative or
positive screening and best-in-class 122- 123.

Pension Funds, specifically, in addition toobserving the social function explainedon section 1 above, must consider intheir risk assessment, whenever possible,
ESG aspects, preferably for each of theirinvestments 115. Moreover, Pensions Funds
should have guidelines in their pension
plans’ investment policies ESG aspects 116.
Insurance Undertakings, in turn, shallobserve ESG aspects, whenever possible,
when allocating their funds 117.
Although in an incipient way, as shownin 9.1.4 to 9.1.9 below, civil society has
been devoting increasing attention to
Sustainability Impact in connection withinvestment and economic exploitation.
The awareness of Sustainability Impact is
at an earlier stage in Brazil than in many
countries, therefore most initiatives –either governmental, from stakeholders
or from civil society – are still limited
to incorporating ESG factors in theirinvestment analysis and monitoring
rather than actually investing to generate
positive Sustainability Impact, either asa goal in itself (ultimate-ends IFSI) or as ameans of value protection in the longterm (instrumental IFSI).
Regarding civil society initiatives, theAMEC Stewardship Code has currently

8.1.5

Some stakeholders have also voluntarily
been adopting Sustainability Impactrelated practices. In this sense, the CEOof Brazilian brokerage firm XP Inc.
(NASDAQ: XP) has been publicly vocal
in urging companies and Asset Owners
to consider ESG matters and actively
engage in stewardship activities 124.
Additionally, several Investment Managers
with over BRL1.7tn (roughly US$310bn)in assets under management (AuM) havesigned the ‘Investors for the Climate’(Investidores pelo Clima – IPC) commitment,
which seeks to engage and persuade
professional investors in Brazil to proceedwith decarbonising their portfolios,
contributing to the achievement of theBrazilian targets in the Paris Agreement,

while seeking returns that are better
adjusted to the risk 125.
8.1.6

8.1.7

8.1.8

There has been an increase in theavailability of market indexes comprised ofshares or units, investment funds’ quotas
and/or debt instruments that are focused on
Sustainability Impact, which offers market
infrastructure for players desiring an
ecosystem structured around Sustainability
Impact. In addition to the traditional
Corporate Sustainability Index (Índice deSustentabilidede Empresarial – ISE), launchedby B3 S.A. – Bolsa, Balcão, Brasil in 2005,
CDP Brazil Climate Resilience Index 126 waslaunched in July 2020 and Brazil ESG Index127
was launched in September 2020. The
monitoring of such indexes has greatly
helped industry and academic research,which has been showing support for the
adoption of strategies that incorporate
Sustainability Impact 128.
A reflection of this is the increase in ESGrelated funds and investment products. For
instance, XP Inc. recently announced thecreation of an ESG board and initiatives toprovide the best products, services, content
and recommendations focused on ESG.
Additionally, XP Inc. has conceived two(2) ESG-focused funds totalling BRL100m(roughly US$18.3m). One fund, called Trend
ESG Global Fundo de Investimento Multimercado,
will be exposed to three foreign exchangetraded funds (ETFs) and a fund-of-funds(FoF) focused on Brazilian companies thathave strong ESG practices.
Discussions with the government andregulators have also increased, which isshown, among other things, by initiatives
such as ENIMPACTO, the National

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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Guidelines on Business and Human Rights,
and recent amendments to the National
Policy on Climate Change (Política Nacional
sobre Mudança do Clima – PNMC) 129 and thecreation of the National Fund on Climate
Change (Fundo Nacional sobre Mudança do
Clima – FNMC), which receives funds fromthe Brazilian federal government andthe states in connection with royalties
arising from petroleum and natural gas
economic exploitation, among otherfunding alternatives. BNDES also includes
generating positive Sustainability Impact
among the qualification requirements for
its tenders and adopts negative screening
to filter projects generating negative
Sustainability Impact out of its portfolio.
CVM has also recently shown interest in
regulating ‘green’ investments 130.
8.1.9

ABVCAP, ANBIMA, FEBRABAN andother stakeholders have committed toconstantly follow sustainability, impact
investing, ESG and other correlated
matters, which shows their growing
importance. Moreover, it could beargued that all of the aforementioned
reflect a shift in investors’ perspective:
Sustainability Impact is ceasing to be acost that only philanthropists and wealthy
investors can afford and becoming anecessary and profitable strategy adiligent manager should undertake.

8.1.10 Furthermore, Asset Owners andInvestment Managers are also starting
to consider the potential liabilities
and reputational damage arisingfrom investments that could result innegative sustainability impacts. Even
though Relevant Investors have not been
consistently and directly considered liable
for the negative Sustainability Impacts of
their investments in Brazilian case law,216

there are important judicial discussions
regarding liability of financial institutions
that could be used, in the future, to argue
that such stakeholders are responsible fornegative Sustainability Impacts 131.
8.1.11 In this context, recent research with around
30,000 investors domiciled in Brazil 132
has shown that around two-thirds havelittle to no knowledge about responsible
investment, from an ESG standpoint.
Despite that, 70 per cent stated that they
were interested in ESG-related investment
products. The research also showed thatthe main concerns about responsible
investment among Brazilian investors were:(a) fear of a financial return trade off 133; (b)fear of greenwashing 134; (c) fear of a higher
inherent risk 135; and (d) lack of knowledge
on the matter 136. In addition to the latter, a
new survey carried out by XP Investimentos
with several institutional investors pointed
to additional struggles faced by theindustry, such as unavailable trustworthy
data on ESG matters and insistence ofspecific regulation of the theme 137.
8.1.12 The public sector – most noticeably the
CVM – is also presenting regulatory
initiatives regarding ESG matters. In
this context, two requests for comments(audiências públicas) are the most remarkable:• Request for Comments No. 08/20.

With notice published in December
2020, the CVM proposed a new
regulatory framework to the formation,
management and disclosure of
information of investment funds. Oneof the proposals in the draft of theregulation refers to concerns addressing
greenwashing and ESG-washing bylimiting the use of words such as ‘social’and ‘environment’ in investment funds’
names to funds that have been verified by

an external independent reviewer, using
internationally recognised methodologies,
to generate social and/or environmental
impact. The proposal only concerns
receivables funds, but market
participants have shown interest in therule being expanded to encompass all
investment funds.
• Request for Comments No. 09/20. With

notice published in December 2020,
the CVM proposed a new regulatory
framework for the disclosure of
information by publicly held companies.
The draft of the regulation mentions that
the CVM perceives increasing interest in
and development around sustainability
issues, and thus proposes improvementsin the content of mandatory disclosure
documents by publicly held companies.
Some of the proposed changes are:the obligation to disclose social,environmental and climate risk factors
which could affect an investment
decision; the requirement to indicate
which Sustainable Development Goals are
relevant to the business of each issuer of
securities and the adoption of ‘comply
or explain’ strategy so that issuers who
do not publish sustainability reports or
performance indicators of ESG matters
explain why they do not; as well as manyother measurable ESG-related data that
could improve the information available
to Asset Owners for composing portfolios
with Sustainability Impact-related goals.
8.1.13 In addition, we believe that in lightof the ongoing COVID-19 pandemic,
governments, investors and otherstakeholders have been showing increasing
interest in Sustainability Impact issues
and re-evaluating their existing strategies
regarding the matter. For instance: (a)ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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more than two dozen financial institutions
around the world, managing more than
US$3.7tn in total assets, have recently
signed and delivered a letter to theBrazilian government expressing theirconcern at increasing deforestation rates in
Brazil, and the possibility they may divest
from Latin America’s largest economy
if Jair Bolsonaro’s administration fails
to curb deforestation in the Amazon 138;and (b) in its public bid notice to allocate
up to BRL4bn (roughly US$730m) in
receivables investment funds as a means
to expand access to credit to micro, small
and medium-sized enterprises which weredeeply affected by the COVID-19 pandemic,
BNDES Participações S.A. required all
proposals to contain a description of theinvestment fund’s social strategy, ie (i) the
portfolio’s expected social impact and (ii)the procedures and mechanisms used tomeasure and monitor the social impact
generated by the fund’s portfolio.
8.2

Financial materiality

8.2.1

Because of the growing importance oftaking account of ESG and sustainability
factors in the investment process where
financially material, it is important tounderstand how the law defines what is‘financially material’ and the period byreference to which financial materiality
must be measured. Taking accountof these factors in order to pursue
financial objectives may incidentally have
Sustainability Impacts and may also be
consistent with IFSI. However, beyond
that point, any attempt to realise positive
Sustainability Impact might need to rely
solely upon IFSI (i.e. because it would nolonger be driven by the need to generate
financial performance).

217

8.2.2

Brazilian law indirectly refers toaccounting rules for defining the concept
of “financial materiality”, pursuant towhich any information that could affectthe economic decisions of the recipientsof the financial information is material
139. Therefore, whenever Sustainability
Impact-related information can affectan investor’s decision to buy, hold or sell
securities of a certain Asset Owner or toinvest in a pension plan, such information
would be deemed material. The ANBIMAESG Guide supports this concept offinancial materiality.

8.3

Period by reference to which‘materiality’ is to be assessed

8.3.1

The regulations in force do not establish
a clear timeframe in which the financial
materiality of the investments comprising aportfolio should be assessed. The judgmentof financial materiality may vary dependingon the investment term or as provided forin the by-laws. All Asset Owners may state
their preferred pre-established criteria
in their respective by-laws or leave theassessment of financial materiality to theInvestment Manager’s discretion, including
whether, which and how ESG aspects shallbe considered in portfolio allocation, as
well as the relevant period for such anassessment. Due to this self-determination,
there is no standard market practice for theassessment of materiality.

ACKNOWLEDGEMENTS

Flávio Barbosa Lugão, Fernanda Basaglia Teodoro,
Tábata Boccanera Guerra de Oliveira, Vitória deAssis Pacheco Morais, Gabriel de Freitas Queiroz,
Eduardo Cezar Delgado de Andrade, Anália
Cristina Ferreira Brum, Júlio Figueiró Melo, Renata
Fonseca Zuccolo Giannella, Juliana Furini deVasconcellos Puntel, Juliana Gomes Ramalho
Monteiro, Luis Eduardo Kussarev Al-Contar,
Ary Oswaldo Mattos Filho, Maria Luiza Miranda
Geraldi, Vinícius Paula Castro, Lina Pimentel
Garcia, Isabela Sartori, Bárbara Gabriel deVasconcelos Silveira, Marcela Venturini Diorio andGabriel Zampieri Ferreira Batista

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia
BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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1

Pursuant to item III of Article 170 of the Federal Constitution.

2

Pursuant to Article 421 of the Civil Code (Law No. 10,406, of 10
January 2002).

11

In case of a sponsored fund, the sponsor also pays a monthly
contribution on behalf of the employee.

3

The social function has roots in the writings of French scholar of
public law Léon Duguid, according to whom law’s most importantrole is to be an instrument for promoting social solidarity andensuring the greater good. Duguid’s conception of law wasincorporated in several legal systems, including Brazil’s, where
the social function constitutes a right and a duty. Pursuant to thisnotion, ‘the right of private ownership includes an obligation to use
property in ways that contribute to the collective or common good’and owners are ‘obligated to refrain from using their property inways that harm others’ (ONDETTI, Gabriel. The social function ofproperty, land rights and social welfare in Brazil. Land Use Policy,[S.l.], v. 50, s/n, pp. 29-37, Jan. 2016).

12

As per the National Monetary Council (Conselho Monetário
Nacional – CMN) Resolution No. 4,661, of 25 May 2018, andthe National Complementary Social Security Superintendence(Superintendência Nacional de Previdência Complementar –PREVIC) Rule No. 6, of 14 November 2018.

13

In this regard, see Law No. 9,613, of 3 March 1998 (Anti-Money
Laundering Law), and Law No. 13,810, of 8 March 2019, which
provides for the immediate compliance with sanctions from theUnited Nations Security Council against individuals or legal entities
regarding the unavailability of assets.

14

PREVIC Rule No. 6, of 13 November 2018, CMN Resolution No. 4,661,
of 25 May 2018, and Complementary Law No. 109, of 29 May 2001.

15

This is provided for in Paragraph 4 of Article 11 of CMN Resolution
No. 4,661, of 25 May 2018. Please note that the expression ‘wheneverpossible’ should be understood as an undertaking of means, notof result; however, interpretations of this provision have never beentested in a Brazilian court of law nor has any regulator issued any
rule providing further guidelines on how to interpret the meaningof this expression. Nonetheless, an analogy could be traced with arecent ruling from the High Court of Justice (Superior Tribunal deJustiça – STJ), the highest Brazilian court competent for interpreting
infra-constitutional rules, rendered on 27 August 2019, in which aninvestor sued the manager of an investment fund for losses incurredin the fund’s portfolio. The court however decided that the manager
had no obligation to guarantee profitability in the investments madein the securities market but only to use its best efforts to pursue thebest profitability possible for the fund’s portfolio considering all apt
investment opportunities in the terms of the fund’s investment policy
stated in the by-laws, thus it could only be held liable if proven thatthe investments made thereby were a result of mismanagement or
reckless management (REsp nº 1.724.722-RJ (2014/0124765-9)). In
the case of the applicability of this precedent to the interpretation of‘whenever possible’ in Paragraph 4 of Article 10 of CMN Resolution
No. 4,661, one could argue that the pension fund must use its
best efforts to seek information regarding the supply chain of
the investments made thereby, including the investments madeby the investment funds invested thereby, in order to make surethere is no use of child labour or workers in a situation analogous
to slavery, operation without the adequate licensing, harassmentin the workplace etc. However, there is a limit to what would bereasonably expected as ‘best efforts’. Legal doctrine sheds light onanother constitutional principle that could help interpret the wording‘whenever possible’, which is the proportionality principle, theapplication of which would mean ESG factors would be sufficiently
incorporated in the pension fund’s pension plan’s investment policies
if they are adequate to achieve the intended purpose, sufficientto accomplish so and proportionate to the restrictions applicable(MENDES, Gilmar Ferreira; BRANCO, Paulo Gustavo Gonet. Curso de
Direito Constitucional. 9ª ed. rev. e atual. São Paulo: Saraiva, 2014).
Those restrictions would largely depend on the methodologies
adopted for selecting assets and/or Investment Managers based onprinciples related to Sustainability Impact.

4

5

6

The social value of labour is a strong axiom in Brazilian law,considering its slavery past. This principle condemns degrading
practices towards workers, such as excessively long shifts, no annual
leave, withholding wages, discrimination of any kind – including
paying lower wages or dismissal based on gender, sexual orientation,
ethnicity or colour – as well as forbidding all sorts of child labour or
labour in conditions analogous to slavery.
Free enterprise is a principle applicable to the Brazilian economicorder, as provided by article 170 of the Federal Constitution
which advocates for economic freedom, including the freedom ofenterprises and individuals to access and compete in the market
without excessive state interference and obstacles imposed by othereconomic agents (ie monopolies, dumping and other practices
damaging to the free market), in other words, it is a condemnationof crony capitalism. In 2019, Law No. 13,874 was enacted, whichcontains the ‘Declaration of Economic Freedom Rights’, whichaims to foster free enterprise through the reaffirmation of thisfundamental principle, the modernisation of the regulation
applicable to investment funds, companies in general and theexercise of economic activities, among other legislative innovations.
Pursuant to the language in said statute, the state shall onlyintervene in regard to the exercise of economic activities in a
subsidiary and exceptional manner.
Legal doctrine in Brazil has showed strong support for adoptinga theory of the firm that, instead of following the shareholder
primacy doctrine, claims that a firm exists to generate welfare
for all of its stakeholders (see, for instance, SILVA, Thiago José da.
Administradores e Acordo de Acionistas. Limites à Vinculação. V. 7.
São Paulo: Quartier Latin, out. 2015. p. 49-71).

7

The Sole Paragraph of Article 2,035 of the Civil Code expressly
states that ‘no convention will prevail if it contradicts public policy
principles, such as those established by this Code to ensure thesocial function of ownership and contract’.

8

As stated herein, such fulfilment could potentially be limited by
the current laws and regulations and contracts applicable to theInvestment Manager.

9

Such argument is strengthened by the Sole Paragraph of Law No.
6,404, of 15 December 1976 (Corporations Law), which states that
‘A controlling shareholder shall use its controlling power in orderto make the corporation accomplish its purpose and perform its
social role, and shall have duties and responsibilities towards theother shareholders of the corporation, those who work for the
corporation and the community in which it operates, the rights
and interests of which the controlling shareholder must loyallyrespect and heed.’

10

218

applicable regulators.

For example, the duty to meet the actuarial obligations of a pension
fund or an insurance undertaking or the duty of an Investment
Manager to act according to the interest of the investment fund theportfolio of which it manages, pursuant to the rules enacted by the16

As per PREVIC Rule No. 6, of 14 November 2018.

17

In other words, transparency, solvency, liquidity and financial,economic and actuarial balance are ensured, as well as the legal
requirements of CMN Resolution No. 4,661, of 25 May 2018, and
PREVIC Rule No. 6, of 14 November 2018, are met..

18

An inherent ingredient to this argument is that IFSI presents
lower risks than traditional investment, which seems to besupported by the current literature. Sources: LEFKOVITZ, Dan.
Does Investing Sustainably Mean Sacrificing Return? Morningstar’s
Sustainability Indexes have posted strong returns; they also score

well on volatility, quality, and financial health. Available at: https://www-prd.morningstar.com/content/dam/marketing/shared/pdfs/
Research/Does_Investing_Sustainably_Mean_Sacrificing_Returns_
March2018.pdf?utm_source=eloqua&utm_medium=email&utm_
campaign=&utm_content=17484. Accessed 11 Feb 2020; NUNES,
Tânia Cristina Silva et al. Are sustainable companies less risky andmore profitable? Revista de Administração, São Paulo, v. 47, n. 3, pp.
422-435, jul./set., 2012.
19

20

Namely: (a) mutual funds (fundos de investimento financeiro – FIFs),
which may have a definite or indefinite term, can invest in financial
assets of all sorts and may be subdivided into (i) fixed-income; (ii)stocks, (iii) foreign exchange and (iv) multi-strategy; (b) market index
funds, which must have an indefinite term, can only have passive
management and follow a specified market index (fundos deinvestimento em índice de mercado – FIIMs); (c) real estate funds,
which must have a definite term, can invest in financial assets
related to the real estate sector, real estate assets and/or shares orunits of companies the corporate purpose of which is related to
the real estate sector (fundos de investimento imobiliário – FIIs);(d) receivables funds, which may have a definite or indefinite term,
can purchase most receivables regardless of the performance of theobligation giving rise to such a credit right, from a single or multiple
assignors (fundos de investimento em direitos creditórios – FIDCs);(e) private equity funds, which must have a definite term, can invest
in shares or units of private companies and must effectively influence
their management (fundos de investimento em participações
– FIPs); and (f) rarer types, which are usually vehicles that have acertain tax advantage in order to attract investment to industries
or areas the development of which is incentivised by the federal
government as a matter of public policy – such industries related
to culture and arts, or companies located in the North or Northeast
Regions of Brazil or in Jequitinhonha Valley. There are also funds offunds (fundos de investimento em cotas de fundos de investimento– FIC-FIs), which may invest in quotas of the aforementioned
investment funds, as applicable. For the purposes of this annex, allthese types of funds will be treated indiscriminately as mutual funds,
unless otherwise stated.
Which oftentimes are financial institutions or subsidiaries thereof
but may be any type of company organised under any corporate
arrangement provided for in Brazilian law – the most common ofwhich are corporations (sociedades anônimas) and limited liability
companies (sociedades limitadas) – or even individuals.

21

Pursuant to CVM Rule No. 555, of 14 December 2014, and, forinstance, to CVM Rule No. 558, of 26 March 2015.

22

In spite of the fact that current regulation establishes that thefiduciary administrator shall constitute the investment fund, Brazilian
investment funds are typically conceived and have their investment
policy established by the Investment Manager.

23

In this context, CVM periodically updates a list of jurisdictions
deemed to be strategically handicapped regarding anti-money
laundering practices, pursuant to Financial Action Task Force
Against Money Laundering and Terrorism Financing – FATF’s
recommendations.

24

Any opportunity to IFSI would have to be compliant with thisregulatory restriction.

25

Note that CVM rules limit which types of securities, assets and rights
each type of investment fund may invest in.

26

Including the potential positive or negative Sustainability Impact asa by-product of the investments made.

27

More on them on section “6. Investment managers’ duties to Invest
for Sustainability Impact” of this document.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia
BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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28

Although commonly provided for in the by-laws of illiquid
investment funds, the existence of a performance fee is notmandatory for any type of investment fund.

42

Meaning a corporation, shares of which or any other securities issued
by which are admitted to trading on a stock exchange market or an
over-the-counter market whether organised or not.

29

Such as negative screening, positive screening, best-in-class, impact
investing and corporate engagement.

43

30

Such as, for fixed-income-based portfolios, credit, ageing list andprofitability analyses; while for variable-income-based portfolios,
forecasts, valuations and sensibility analyses.

Pursuant to which officers and directors shall inform theshareholders about certain material information, acts and facts
according to the applicable regulation.

44

As per the SUSEP Circular No. 517, of 30 June 2015.

45

CMN Resolution No. 4,444, of 13 November 2015, andComplimentary Law No. 109, of 29 May 2001.

46

Pursuant to Article 192 of Law No. 6,404, of 15 December 1976.

47

The guidelines referred to herein, provided for in Article 5 of LawDecree No. 73, of 21 November 1966, much like Article 170 of theFederal Constitution referred to mostly in 1 above – which statesthat the economic order of Brazil is founded in the social values oflabour and free enterprise, has the objective to must ensure all adignifying existence, pursuant to social justice commandments andmust observe the principles of national sovereignty, private property,social function of ownership, free competition, consumer protection,
environmental protection, decrease in regional and social inequality,
full employment and different treatment to small companies
incorporated in Brazil – is a programmatic norm and, as such, haslittle practical effect, limiting itself to enunciate principles andobjectives to be pursued. It depends on the establishment of further
regulation by law, decree or norms enacted by a specific regulator –in case of the National Private Insurance Policy, this regulator is the
National Private Insurances Council (Conselho Nacional de Seguros
Privados – CNSP) and SUSEP.

31

32

The preamble of the ANBIMA ESG Guide states the best practicerecommendations made therein were based on the practices
witnessed by ANBIMA’s Sustainability Consulting Group – acommittee thereof – in some of the largest Investment Managers
operating in Brazil.
From a regulatory perspective, there are no relevant differences
between OPPE, general insurance companies and life insurancecompanies or reinsurance companies, since they are all: (a) companies
incorporated as corporations (sociedades anônimaa, also known as‘S.A.’); and (b) supervised by the Brazilian (Re)Insurance Authority(Superintendência Nacional de Seguros Privados – SUSEP), whereas
their allocation limits are set forth in CMN Resolution No. 4,444, of
13 November 2015. The main difference refers to their license, since
SUSEP shall grant specific approvals for them to operate.

33

In Brazil, open private pension plans can be managed both by
OPPEs or insurance companies duly authorised by SUSEP.

34

Pursuant to Law-Decree No. 73, of 21 November 1966, andComplementary Law No. 126, of 15 January 2007.

35

CMN Resolution No. 4,444, of 13 November 2015.

36

CMN Resolution No. 4,444, of 13 November 2015, sets forth manyrules with which any investment fund that is invested by an
Insurance Undertaking must comply.

37

Pursuant to articles 153 to 157 of Law No. 6,404, of 15 December 1976.

38

Pursuant to which officers and directors shall act with the careand diligence as reasonably performed by an active and honest
individual dealing with his/her own businesses.

39

Pursuant to which officers and directors shall act according to thelaw and the by-laws in order to pursue the company’s interest.
As a result, officers and directors shall not (a) perform any act ofgenerosity to the detriment of the company; (b) borrow money orproperty from the company or use, for his/her own benefit or forthe benefit of a third party or of a company in which he or she has
an interest, the company’s properties, services or credits, without
the relevant corporate prior approval; and (c) by virtue of his/her
position, receive any type of direct or indirect, personal advantage
from third parties, without authorisation in the by-laws or from theshareholders’ general meeting.

40

41

219

Pursuant to which officers and directors shall not (a) use any
commercial opportunity which may come to his/her knowledge, by
virtue of his/her position, for his or her own benefit or that of a third
party, regardless of whether it causes any loss to the company; (b) failto exercise or protect the company’s rights or, in seeking to obtain
advantages for himself/herself or for a third party, fail to make use of
a commercial opportunity which he or she knows to be of interest to
the company; and (c) acquire, for resale with profit, property or rights
which he or she knows the company needs or which the company
intends to acquire. Additionally, officers and directors must maintainsecrecy as to any information not disclosed to the public, obtained
as a result of their position and which may influence the trading
value of the company’s securities.
Pursuant to which officers and directors are prevented from voting,or interfering with other members’ votes, in any resolution in whichsuch director or officer may have an interest that conflicts with thecompany’s interest.

48

55

Pursuant to Article 36 of Law No. 12,529, of 30 November 2011.

56

In Brazil, there is no specific exemption for any type of arrangement.
See, for example, the CADE note on collaboration between
competitors to face the COVID-19 outbreak, released on 6 July
2020. In this document, CADE stresses that competition rules andenforcement will not be soften during the period of the pandemic
crises and that ‘economic agents will continue to be responsible forthe evaluation of their strategies and any indications of practices
that are harmful to competition may give rise to the opening ofinvestigations by the authority’.

57

58

Please refer to footnote No. 14, as the arguments presented
therein would also be applicable to the interpretation of thebounds of the expression ‘whenever possible’ in relation to Item
V of Article 2 of CMN Resolution No. 4,444, of 13 November
2015: ‘Article 2. In the deployment of the funds covered by thisResolution, insurance companies, capitalisation companies
and OPPEs shall: […] V – observe, whenever possible, aspects
related to economic, environmental, social and governancesustainability of their investment’.

49

Pursuant to CMN Resolution No. 4,444, of 13 November 2015, and
CNSP Resolution No. 321, of 15 July 2015.

50

This, however, should not prevent the engagement in charity or nonprofit making corporate social responsibility activities.

51

This may be related to the fact that Brazilian companies havetraditionally had very concentrated ownership and control has
traditionally been exercised by a clearly defined majority shareholder.

52

independently, CADE has to define the relevant product andgeographic market in the specific case.

Those are phrased as commandments that the adherent Asset
Owners should follow and they read as: (a) implement anddisclosure a stewardship programme; (b) implement and disclosure
mechanisms to manage conflicts of interest; (c) take ESG factors into
account in their investment processes and stewardship activities;(d) monitor the issuers of securities; (e) be active and diligent in theexercise of voting rights; (f) establish collective engagement criteria;and (g) be transparent as to their stewardship activities. Furthermore,an annual report on the stewardship activities carried out in theprevious fiscal year should be published by each Asset Owner who
adheres to the AMEC Stewardship Code.

53

Source: ASSOCIATION OF CAPITAL MARKET INVESTORS. AMEC
Stewardship Code. [2016]. Available at: https://en.amecbrasil.org.br/stewardship/amec-stewardship-code/. Accessed 18 April 2021.

54

Please note that relevant investors and Asset Owners that do notseem to compete in a given market may be seen as competitors
by the Administrative Council for Economic Defense (Conselho
Administrativo de Defesa Econômica – CADE). In order to identify
actual competitors in a specific market, ie those that are capableof constraining each other and preventing them from behaving

Eg see Merger Case No. 08700.006723/2015-21 (broadcasting
networks Record, SBT and Rede TV); Merger Case No.
08700.002792/2016-47 (five of the largest banks in Brazil); Merger
Case No. 08012.007477/2011-50 (Brazilian Union of Recycling
Electric Appliances and Electronics (Associação Brasileira de
Reciclagem de Eletroeletrônicos e Eletrodomésticos – ABREE));
and Merger Case No. 08700.005278/2014-00 (Jogue Limpo
Institute, which provides services of reverse logistics for lubricants).
In these cases, companies adopted firewalls and measures toprevent antitrust risks, such as the exchange of competitive
sensitive information, and received CADE’s green light to engage incollaborative arrangements.
Relevant Investors and Asset Owners interested in engaging in
stewardship activities to secure Sustainability Impact may establish
protocols to make sure that the discussions do not involve theexchange of data/information, and to minimise any risks related
to the necessary exchange of information, such as the use of athird-party independent consultant. Depending on the specificfacts of a given cooperation, it would also be possible to seek a
CADE pronouncement on the collaborative arrangement andthe stewardship strategy in other to avoid antitrust risks. If thecollaborative arrangement meets the criteria established in Article
88 of the Brazilian Competition Law, and is subject to mandatory
antitrust clearance, CADE will decide whether the arrangement
may occur. However, if the collaborative arrangement is not subject
to mandatory review by CADE, Relevant Investors may still seek
CADE’s pronouncement by (a) filing a petition to obtain a written
and non-binding pronouncement on the agreement or by (b)filing a consultation to obtain a binding pronouncement from
CADE’s tribunal. The procedure and requirements for submitting
a consultation are described in CADE Resolution No. 12, dated 11
March 2015.

59

Please refer to 2.2.13 and 2.2.14 for a discussion on these guidelines.

60

An argument can be made that if the stewardship is likely topreserve value in the long run, then the actuarial obligations are notbeing jeopardised, unless, for some reason, the pension funds must
make large short-term cash payments and do not have sufficientliquidity to meet their obligations.

61

The United Nations’ Global Compact has been developing anticorruption collective actions for the past 10 years and the Brazilian
local network has been selected in 2020 for a four-year projectcalled ‘Scaling up anti-corruption collective action within Global
Compact Local Networks’, which is assisted in the implementationof these collective actions by a consulting council comprised of 20
organisations coming from the public sector, the private sector andcivil society. The current composition of such a consulting council
currently features at least one pension fund.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia
BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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62

Source: ASSOCIATION OF CAPITAL MARKET INVESTORS. AMEC
Stewardship Code. [2016]. Available at: https://en.amecbrasil.org.br/stewardship/amec-stewardship-code/. Accessed 9 December 2019.

63

As per CVM Rule No. 578, of 30 August 2016.

64

It should be noted that an Investment Manager with a small
investment decision-making team may often find the cost of
stewardship activities greater than the benefits that could arise
therefrom. As all costs of engagement are born directly or indirectlyby the Investment Manager – in the second case through a smaller
portion of the management fee to which it would be entitled, in casethe expenses are directly borne by the fiduciary administrator – thecompensation of the Investment Manager could also be related to its
willingness to engage in stewardship: where there is a performancefee, there would be a greater incentive to maintain such human andtechnical resources and develop stewardship activities.

65

An argument can be made that if the stewardship is likely topreserve value in the long run, then the actuarial obligations are notbeing jeopardised, unless, for some reason, the OPPE must makelarge short-term cash payments and has no sufficient liquidity.

66

For example, some pension funds have voluntarily participated in
the four-year project ‘Fiduciary duty in the 21st century’, coordinatedby United Nations Environment Programme’s Finance Initiative andsupported by the Generation Foundation, which advocates for thecritical importance of incorporating ESG standards into regulatory
conceptions of fiduciary duty.

67

The same indirect lobbying strategy could be achieved through a
company instead of an investment fund.

68

For example, the investment policy or any other internal policyor organisational document adopted thereby, as well as, whereapplicable, the investment management agreement, in case of aninvestment fund.

69

Stated by Law No. 13,874, of 20 September 2019.

70

It should be noted that the CVM has published a request forcomments (audiência pública) aimed at reforming the regulations
applicable to the periodic and eventual disclosure of information
by public companies. The proposed regulation on which market
participants were asked to comment, among others, provides formany indicators related to ESG aspects and the disclosure of socialand environmental risks, as well as those related to climate change.

71

According to a recent poll, one in every four Brazilian investors wasafraid of a trade-off between IFSI and financial return (please refer
to footnote No. 142 for further details). The discussion in Brazil about
ESG and Sustainability Impact has greatly increased since 2020,
being the main theme of a number of investor education events
held in the past months, thus it is likely that more investors will forgo
this mindset and will be more willing to pursue IFSI.

72 		Three studies are worth mentioning, all of which found morepositive than negative or neutral results regarding how ESG factors
affect financial performance. The first one, a meta-analysis fromthe University of Hamburg and WDS Investment covered around
2,250 studies published since 1970, found that approximately 48
per cent of the analysed studies that found a statistical significant
relationship between ESG and corporate financial performanceand approximately 62 per cent of the analysed meta-studies point
to a positive relationship between ESG and corporate financial
performance, while only 10 per cent found a negative relationshipand the rest found a neutral relationship (DWS INVESTMENT.
Digging deeper into the ESG-corporate-financial-performancerelationship. Frankfurt am Main: DWS Global Research Institute,
13 Set. 2018. Available at: https://www.google.com/url?sa=t&rct=j&
q=&esrc=s&source=web&cd=&ved=2ahUKEwjdm7nupbrxAhWOq
pUCHRlDAr0QFjAAegQIAxAD&url=https%3A%2F%2Fdownload.
dws.com%2Fdownload%3Felib-assetguid%3D714aed4c2e8347
1787d1ca0f1b559006&usg=AOvVaw3aFLi7e9_lqrW-oQ0G2cUD.

220

Accessed 28 June 2021). The second one, a meta-analysis fromthe University of New York’s Stern Center for Sustainable Businessand Rockefeller Asset Management covered 1,141 peer-reviewed
papers and 27 meta-reviews (on their turn based on approximately
1,400 studies) published between 2015 and 2020, found that, whenanalysed from a long-term perspective, ESG integration provides
downside protection – especially in times of a social or economiccrisis – sustainability initiatives and low-carbon management drive
better financial performance at corporations, and ESG disclosure
without an accompanying sustainability strategy does not drive
financial performance, among other findings. ‘Dividing articles
into those focused on corporate financial performance and those
focused on investment performance, the researchers found apositive relationship between ESG and financial performancein 58 per cent of the corporate studies focused on operational
metrics or stock price with 13 per cent showing neutral impact,
21 per cent mixed results and only 8 per cent showing a negative
relationship. For investment studies, typically focused onrisk-adjusted attributes, 59 per cent showed similar or better
performance relative to conventional investment approaches
while only 14 per cent found negative results’ (WHELAN, Tensie
et al. ESG and Financial Performance: Uncovering the relationshipby aggregating evidence from 1,000 plus studies publishedbetween 2015 – 2020. [Nova York (NY)]: Leonard N. Stern Schoolof Business, 10 Feb. 2021. Available at: https://www.stern.nyu.edu/
experience-stern/about/departments-centers-initiatives/centersof-research/center-sustainable-business/career-development/
career-resources-job-board. Accessed 28 June 2021). The third
is United Nations’ Principles for Responsible Investment’s own
work, which also found a connection between ESG factors andshareholder returns (PRINCIPLES FOR RESPONSIBLE INVESTMENT.
Financial performance of ESG integration in US investing. [S.l.]:
United Nations’ Principles for Responsible Investment, 2018.
Available at: https://www.unpri.org/download?ac=4218. Accessed
28 June 2021). Moreover, evidence from the Brazilian market also
points to a positive relationship between social performance andfinancial performance and to a lack of relationship between financial
performance and disclosure of social factors unaccompanied
by an underlying social responsibility strategy (AEDO PEREIRA,
Anderson Felipe et al. Corporate Social Performance and Financial
Performance in Brazilian Companies: Analysis of the Influence ofDisclosure. Vitória (ES), Brazilian Business Review, v. 17, n. 5, p 540558, Sep./Oct. 2020. Available at: http://bbronline.com.br/index.php/
bbr/article/view/618/927. Accessed 28 June 2021).
73

Although Brazilian law does not provide for a definition of ‘welfare’, itis generally understood as encompassing striving for a higher level ofwellbeing achieved through access to decent healthcare, education,
housing, labour conditions and other things. Higher financial payoffs
could grant access to these services, but those could also be directly
provided by Pension Funds to their pensioners and to the community.

74

When the sponsor is related to the public administration, however,formal consent is required – not just proof of prior notice.

75

Pursuant to Complimentary Law No. 109, of 29 May 2001, and
PREVIC’s Licensing Department Ordinance No. 324, of 27 April 2020.

76

PREVIC Rule No. 6, of 14 November 2018, sets forth that theinvestment policies of Pension Funds’ pension plans must establish
guidelines for Pension Funds to follow in order to consider ESG
factors in their investments. These guidelines aim to provide
a framework under which ESG must be integrated in the risk
analysis of the investment portfolio, considering each specificindustry invested in. Since the referenced rule does not contain any
specification with regard to these guidelines, they could, in practice,
be generally mentioned in the investment policies, as to express thatESG factors should be considered in the investment risk assessment
and portfolio allocation.

77

Rule No. 6, of 14 November 2018.
78

For instance, (a) JGP ESG Master Fundo de Investimento em Ações,enrolled with the Legal Entity National Registry of the Ministry of
Economy (Cadastro Nacional de Pessoa Jurídica – CNPJ) underNo. 35.400.868/0001-63; (b) Pátria Crédito Estruturado Fundo deInvestimento em Direitos Creditórios, enrolled with the CNPJ underNo. 28.819.553/0001-90; and (c) Constellation Compounders ESG
Fundo de Investimento de Ações, enrolled with the CNPJ under No.
18.872.811/0001-48.

79

Unless a higher quorum is provided for in the by-laws.

80

Therefore, this duty is not owed to the shareholders and otherbeneficiaries related to securities issued by the Insurance Undertaking.

81

It should be noted that the CVM published notice of a request forcomments (audiência pública) on 1 December 2020 regarding
a new regulation proposal applicable to investment funds. If theenacted regulation piece maintains CVM’s initial proposal, theInvestment Manager will, jointly with the fiduciary administrator,
form the fund through a joint written resolution approving theformation of the fund and stating its by-laws, which shall then beregistered with the CVM. In this scenario, there will be no morenecessary investment management agreement to be enteredinto between the fund and the Investment Manager, but rather
the powers thereof will be directly stated in the by-laws and in
the applicable regulation, without prejudice, in any case, of theexecution of ancillary agreements between the Investment Manager
and the fund and/or the quotaholders further governing how theportfolio should be managed.

82

Which are: (a) for pension funds, (i) the National Complimentary
Social Security Council (Conselho Nacional de Previdência
Complementar – CNPC) and (ii) PREVIC; (b) for mutual funds, (i)CMN and (ii) the CVM; and (c) for Insurance Undertakings, (i) the
CNSP and (ii) SUSEP. A few duties and powers of Pension Funds’ and
OPPEs’ investment decision-makers are also set by Complimentary
Law No. 109, of 29 May 2001, and Law No. 6,404, of 15 December
1976, which sets forth the duties and powers applicable to theofficers and directors of Insurance Undertakings.

83

In any case, under the terms of the CMN regulation and, in case of
mutual funds, the CVM.

84

Eg restrictions on locations, industries, age or size of invested
companies; restrictions on the amount of time for which the asset
must be held; restrictions on the stake that may be purchased onbehalf of the Asset Owner – controlling or minority shareholder – etc.

85

Except in index funds, where these powers may be exercised directlyby the quotaholders.

86

It is arguable that even when the pursuit of Sustainability Impact
is not expressly stated in the organisational documents of an Asset
Owner or on the investment management agreement, if (a) there
is wording related to the pursuit of long-term returns; and (b) areasonable link could be made between the long-term profitability
and likelihood of success of investments and their Sustainability
Impact, the Investment Manager could invest in potentially positive
Sustainability Impact projects, regardless of potential lower shortterm returns and without prejudice to its liability towards the CVM.
It should be noted, however, that there is no clear definition for thetimeframe in which this assessment should be carried out.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia
BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Pursuant to CMN Resolution No. 4,661, of 25 May 2018, and PREVIC

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

BRAZILCONTENTSFOREWORDSINTRODUCTION
87

88

89

90

Alternatively, this could also be set in a sustainability policy adopted
by the Investment Manager. On this topic, it should be highlighted
that the largest Investment Managers in Brazil are financial
institutions or are controlled by a financial institution and, as such,they are required by CMN Resolution No. 4,327, of 25 April 2014, toestablish a social and environmental responsibility policy (política
de responsabilidade socioambiental – SERP) which is applicable,
pursuant to the Central Bank of Brazil’s oversight, to all entities thathave a financial institution in their prudential conglomerate. The
SERP should contain (a) the social and environmental principles
and guidelines that these entities have to follow when conducting
their business, including deploying capital managed on behalf ofthird-parties, and (b) how these entities will manage the social andenvironmental risks to which they and their assets are exposed.
Furthermore, the Brazilian Banks Federation (Federação Brasileirade Bancos – FEBRABAN), in the capacity of a self-regulatoryorganisation, has set non-mandatory guidelines regarding fordrafting the SERP which require the entities that are subject thereto
to consider ESG factors when selecting and monitoring assets tocomprise their investment portfolios, since these factors could affectthe risk-return ratio associated with the investment.
The appropriateness or sufficiency of the human and technicalresources adopted by the Investment Manager will be measured
against the activities that it sets itself to perform, considering aspects
such as nature, size, complexity etc. Ultimately, if the CVM deems
that the Investment Manager is not qualified to pursue IFSI, it may
bar it from managing a portfolio in order to pursue IFSI, either as anultimate end or instrumentally.
Having said that, a relevant example is the Investors Policy Dialogue
on Deforestation – IPDD Initiative, set up in July 2020, to coordinate
a public policy dialogue with Brazilian government-related
authorities and associations, as well as other stakeholders on halting
deforestation. It marks the start of an ongoing process of investor
engagement with Brazilian authorities and associations on thesystematic and sustainable management of Brazil’s forest assets andon ensuring respect for human rights. The IPDD Initiative has had a
lot of media attention and counts with the participation of dozens ofInvestment Managers who hold assets in Brazil.
In this case, liability could be civil or administrative. Civil liability.
A Pension Fund or its managers and investment decisionmakers
in relation to the participants of the pension plan and/or to thesponsor, an investment fund to its quotaholders or the relevant
officers and directors to the Insurance Undertaking itself, as well as
the Investment Manager to the same persons or to the Asset Owner
itself, could be held civilly liable for breach of applicable regulation,
especially breach of fiduciary duties, and breach of contractual
obligations set forth in the relevant documents – please refer tofootnote No. 102 for a list of these documents. Administrative
liability. Sanctions could be levied by PREVIC to the managers
of a Pension Fund – or the Pension Fund itself, who would thenhave recourse against the managers – by SUSEP to an Insurance
Undertaking’s relevant officers and by the CVM to an Investment
Manager and its officer liable for the portfolio management activity.
Poor performance of investments cannot result in administrative
liability, provided that there has not been any practice of a crime,
breach of obligations undertaken in the relevant documents andregulation or fraudulent or negligent performance of its functions.

91

In this case, there could be civil contractual liability (eg where
the investment in the investee company was made through asustainability bond).

92

The Sole Paragraph of Article 927 of the Civil Code states that ‘there
will be an obligation to repair the damage, independent of fault,
in the cases specified in the law, or when the activity as normallyconducted by the perpetrator of the damage implies, by its
nature, risk to the rights of another’. Brazilian case law has mostly
maintained the interpretation that strict liability will only occur in

221

Undertaking: (i) the by-laws of the Insurance Undertaking and/or (ii)the insurance or reinsurance policies; and/or (iii) the pension plan’s
by-laws of an OPPE and its investment policies.

ACKNOWLEDGEMENTS

106

According to Law No. 9,784, of 29 January 1999, Decree No. 4,942, of
30 December 2003.

EXECUTIVE SUMMARY

107

According to Law No. 9,784, of 29 January 1999, Law No. 13,506, of
13 November 2017, and CVM Rule No. 607, of 17 June 2019.

108

According to Law No. 9,784, of 29 January 1999, and CNSP
Resolution No. 393, of 30 October 2020.

109

Brazilian law does not admit, however, that anyone be held liable
exclusively on the grounds of their position within a company’sorganogram, as it must be demonstrated that they contributed
somehow to the breach of contract or violation of law.

110

Please refer to 7.2.4 to 7.2.10 above for an explanation of theconcept of ‘indirect polluter’ and the claim of damages through acollective action..

111

The general provisions set forth in the caption of Article 13 and in
Article 29 of the Penal Code (Law-Decree No. 2,848, of 7 December1940), ground this statement. Brazilian law does not admit, however,that anyone can be charged with exclusive grounds on their position
within an organogram, as it must be demonstrated that they
contributed somehow to the offence.

exceptional cases, either by express legal determination or on theoccasion of activities that represent a risk inherent to the rights ofthird parties.
93

For instance, it would not be uncommon in a private equity deal for
the Asset Owner to agree to reimburse the opposing party, either on
the sell- or buy-side, in case environmental damages or violations ofhuman rights and other liability arising from negative Sustainability
Impact prior to the transaction are discovered after the transaction
has taken place.

94

Investment funds have no corporate veil as they lack legal personality,
as stated in 2.3.1. Thus, any case of civil liability could result in an
obligation of the quotaholders to contribute more capital to pay forthe indemnity, as their liability when subscribing for quotas of theinvestment funds is not limited to the contributed capital.

95

For further explanation on the social function concept, refer to
Section 1 above.

96

Such an action is called a ‘collective action’ or ‘public civil action’(ação civil pública) and the claim must be related to moral ormaterial damages: (a) to the environment; (b) to consumers,
pursuant to consumer protection laws; (c) to goods with artistic,
aesthetic, touristic or landscape value; (d) to any other collective or
diffuse interest; (e) arising from an infraction to the economic order;(f) to the urban order; (g) to the honour and dignity of racial, ethnicor religious groups; or (h) to public and social heritage.

97

2nd Regional Labour Court. Appeal No. 0000108-81.2012.5.02.0081–
SP, Judge-Rapporteur Sonia Maria de Barros, judged on 8 October
2017. Under the terms of the decision, ‘it is irrelevant that thecontracts maintained with the outsourced companies contained
clauses with the obligation of not subcontracting sewing
workshops in irregular conditions’.

98

As stated in Law No. 6,938, of 31 August 1981.

99

Any incident or violation of environmental laws may potentiallygive rise to civil, administrative and criminal liabilities. This section
covers only civil liability, ie criminal or administrative liability still may
require that causation is established.

100

101

Brazilian Superior Court of Justice, Especial Appeal No. 650,728,
Judge-Rapporteur Justice Herman Benjamin, judged on 23 October
2007, published on 2 December 2009.
Brazilian Superior Court of Justice, Repetitive Especial Appeal
No. 1.596.081, Judge-Rapporteur Justice Ricardo Villas-Bôas
Cueva, judgement rendered on 25 October 2017, published on
22 November 2017. Pursuant to Article 927 of the Code of Civil
Procedure (Law No. 13,105, of 16 March 2015), this a binding
precedent that must be observed by the courts.

102

Pursuant to Article 4 of Law No. 9,605, of 12 February 1998.

103

An investment fund itself would not be liable before the CVM.
However, a fiduciary administrator thereof and its officer(s) liable forthe activity of fiduciary administration could be liable if it breaches
its duties, including duties related to oversight of the Investment
Manager. For a summary of the duties of the fiduciary administratorof an investment fund, please refer to 2.3.3 and 2.3.4.

104

Please refer to footnote No. 100 in relation to investment funds.

105

The relevant documents we refer to are (a) in case of a Pension Fund:(i) the by-laws of the Pension Fund, (ii) the by-laws of the pension
plan or its investment policies, or (iii) the investment managementagreement through which the Investment Manager was engaged,
if applicable, and, (iv) if an Investment Manager was engaged, its
by-laws or articles of association or its sustainability policy; (b) incase of an investment fund: (i) the fund’s by-laws, (ii) the investment
management agreement through which the Investment Manager
was engaged or (iii) the Investment Manager’s by-laws or articles ofassociation or its sustainability policy; or (c) in case of an Insurance

112

Please note that in Brazilian law, ‘fault by means of negligence’(culpa) includes acts carried out with carelessness (negligência),
recklessness (imprudência) or inaptness (imperícia).

113

Liability of Investment Managers and their officers would have to beconnected with their duties of executing investment and divestment
orders and representing the investment fund in the exercise of any
right arising from holding the securities and other assets in thefund’s portfolio or with their duties of adequately managing the risks
associated with the portfolio, without prejudice to duties connectedto the disclosure of information of the Investment Manager itself
to the market and to the CVM. Liability could also arise for a failure
to verify the suitability of an investment to a quotaholder, in case
the Investment Manager directly distributes the quotas of theinvestment fund to the beneficiaries.

114

This would be an objective violation, thus not require proof of
negligence or wilful misconduct in the violation of CVM regulation.
Additionally, please note that in Brazilian law, ‘negligence’(culpa) includes acts carried out with carelessness (negligência),
recklessness (imprudência) or inaptness (imperícia).

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia
BrazilCanadaChina

European Union
FranceJapan

115

This provision is established by Paragraph 4 of Article 10 of CMN
Resolution No. 4,661, of 25 May 2018.

116

Pursuant to Article 23 of PREVIC Rule No. 6, of 14 November 2018.

117

Pursuant to Item V of Article 2 of CMN Resolution No. 4,444, of 13
November 2015.

South Africa

118

Source: ASSOCIAÇÃO DE INVESTIDORES NO MERCADO DE
CAPITAIS. Signatários. Available at: https://www.amecbrasil.org.br/stewardship/signatarios/. Accessed 12 April 2021.

United Kingdom

119

Together, the assets under management of all Pension Funds
adherent to the AMEC Stewardship Code correspond to more than
44 per cent of all assets under management by Pensions Funds
in Brazil ((Source: ASSOCIAÇÃO DE INVESTIDORES NO MERCADO
DE CAPITAIS. Stewardship. Signatários. Available at: https://www.
amecbrasil.org.br/stewardship/signatarios/. Accessed 12 April
2021; together with ASSOCIAÇÃO BRASILEIRA DAS ENTIDADESFECHADAS DE PREVIDÊNCIA COMPLEMENTAR; INSTITUTO
BRASILEIRO DE GEOGRAFIA E ESTATÍSTICA. Consolidado Estatístico.
Agosto/19. Available at: https://www.abrapp.org.br/wp-content/
uploads/2021/04/Consolidado-Estatistico_12_2020.pdf. Accessed 12
April 2021).

Netherlands

United States

GLOSSARY
REFERENCES

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BRAZILCONTENTSFOREWORDSINTRODUCTION
120

This company is a subsidiary of the Social and Economic
Development Bank (Banco Nacional do Desenvolvimento
Econômico e Social – BNDES).

121

All of which are in Segment 1 of the prudential segmentation
implemented by CMN. According to Article 2, First Paragraph,of CMN Resolution No. 4,553, of 30 January 2017, Segment 1 iscomprised of banks and state-owned companies that are allowed
to perform banking activities the size of which equals 10 per centor more of the gross domestic product or that have significant
international presence, regardless of their size. Source: BANCO
CENTRAL DO BRASIL. Segmento 1. [2019]. Available at: https://www.
bcb.gov.br/acessoinformacao/legado?url=https:%2F%2Fwww.bcb.
gov.br%2Fnor%2Fbasileia%2Fs1.asp%3Fidpai%3Denquadramento.
Accessed 19 November 2019.

122

123

Source: ASSOCIAÇÃO BRASILEIRA DAS ENTIDADES DOS
MERCADOS FINANCEIRO E DE CAPITAIS. GUIA ASG. Incorporação
dos aspectos ASG nas análises de investimento. [S.l.]: ANBIMA, jan.
2020. Available at: https://www.anbima.com.br/data/files/1A/50/
EE/31/BFDEF610CA9C4DF69B2BA2A8/ANBIMA-Guia-ASG-2019.pdf.
Accessed 18 February 2020.
It is safe to assume that almost all the most relevant Investment
Managers acting in the Brazilian investment funds industry
are comprised in said research, since around 71 per cent of all
Investment Managers are registered with ANBIMA.

131

132

For example, in recent lawsuits proposed against public and private
financial institutions, the public prosecutor’s office has argued thatbanks have neglected social and environmental risks in providing
credit to businesses that engaged in slave labour and other humanrights violations. Among other requests, courts have been asked
to order these financial institutions to include in their contracts
clauses that recognise social and environmental obligations, as wellas financial consequences for non-compliance by the investees (seePublic Civil Actions No. 1000641-81.2019.5.02.0047 and No. 100063903.2019.5.02.0083 at São Paulo’s Labour Court, proposed against
Banco Safra S.A. and Caixa Econômica Federal S.A., respectively).
BERTÃO, Naiara. ESG: sobra interesse, mas falta informação,mostra pesquisa da XP. Valor Investe. São Paulo. 14 ago. 2020
Available at: https://valorinveste.globo.com/objetivo/hora-de-investir/
noticia/2020/08/14/esg-sobra-interesse-mas-falta-informacao-mostrapesquisa-da-xp.ghtml. Accessed 16 Aug 2020.

133

A concern shared by 24 per cent of the respondents.

134

A concern shared by 24 per cent of the respondents.

135

A concern shared by 19 per cent of the respondents.

136

A concern shared by 17 per cent of the respondents.

137

Source: SCHINCARIOL, Juliana, Investidor institucional
mostra desconhecimento sobre ESG, Valor Econômico,
Rio de Janeiro, 14. April 2021. Available at: ttps://valor.
globo.com/wall-concurrence/?next=https://valor.globo.com/
financas/noticia/2021/04/14/investidor-institucional-mostradesconhecimento-sobreesg.ghtml?utm_source=valorinveste&utm_
medium=referral&utm_campaign=materia. Accessed: 15 April 2021.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXES

124

Source: ADACHI, Vanessa. Guilherme Benchimol, da XP: “Empresa
que não for ESG vai acabar”. Capital Reset. 26 June 2020. Available
at: https://www.capitalreset.com/guilherme-benchimol-da-xpempresa-que-nao-for-esg-vai-acabar/. Accessed 5 July 2020.

125

Available at: https://www.english.climaesociedade.org/post/sitawiinvestors-for-the-climate. Accessed 10 July 2020.

138

Available at: https://www.ft.com/content/ad1d7176-ce6c-4a9b-9bbccbdb6691084f. Accessed 13 July 2020.

Australia

126

Created in March 2020 by the British NGO Carbon Disclosure
Project (CDP), this index intends to establish a relationship between
the disclosure of environmental data and local companies’ financial
performance. It began to be disclosed as from 13 July 2020 on Valor
Econômico’s website. The index initially comprises 34 of the mostliquid companies in the Brazilian market that achieved at least a ‘C’score in CDP’s methodology, which varies from ‘A’ to ‘D’. Despite theshort comparison period, ICDPR has outperformed IBOVESPA (themain stock market index in Brazil which tracks the most actively
traded stocks) from April to June 2020. This index tends to provide
a good metric for the relation between Sustainability Impact data
disclosure and financial return and to encourage other relevant
investors to engage in Sustainability Impact businesses considering
ICPR’s financial return.

139

According to the Technical General Brazilian Accounting Rule No.
23, twice amended, which internalises the provisions set forth in
the Accounting International Standard No. 8 of the International
Accounting Standards Board – IASB.

Canada127

The Brazil ESG Index is a broad-based index that is designed tomeasure the performance of securities meeting sustainability criteria
and weighted by S&P DJI ESG score. The index applies exclusions
based on companies’ involvement in specific business activities,
performance against the principles of United Nations Global
Compact, and companies with no S&P DJI ESG score listed in theexchange market operated by B3 S.A. – Bolsa, Balcão, Brasil.

128

In addition to the more recent initiatives, B3 S.A. – Bolsa, Balcão,Brasil’s commitment to the ESG theme goes back to 2004, when it
was the first stock exchange to adhere to the UN Global Pact and wasa founding signatory of the UN Sustainable Stock Exchanges (SSE).

129

Reference is made to the inclusion of Item X into Article 170 of theFederal Constitution, stating the all economic activity in Brazil mustbe guided by the need to ‘promote climate stability, by usage of
mitigating measures to prevent climate change and adapt to its
negative effects’.

130

222

JURISDICTION REPORTS

BrazilChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES‘Audiência Pública SDM nº 04/18 – Processo CVM SEI nº
19957.0037762017-67’. Available at: http://www.cvm.gov.br/audiencias_
publicas/ap_sdm/2018/sdm0418.html. Accessed 13 July 2020.

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCANADA

CONTENTSFOREWORDSINTRODUCTION

1.

INTRODUCTION

1.1

For the purposes of this annex, we haveconsidered the laws of Canada as at 31
January 2021. Canada is composed of ten
provinces and three territories. Quebec
is a civil law jurisdiction. The otherprovinces/territories are common law
jurisdictions, as is Canadian federal law.
Unless otherwise stated, the information
contained herein applies in general terms
to all provinces/territories. Where there
are significant distinctions in respect ofQuebec, they are addressed separately.

1.1.1

As discussed in the main body of thereport, the expression ‘Investing for
Sustainability Impact’ (“IFSI”) is not a
precisely defined legal expression, and it
is important to emphasise that the lawsof Canada do not reference it in that way.
Rather, the expression is used here as a
type of ‘conceptual net’ to catch any power
or freedom on the part of Asset Owners or
their Investment Managers to pursue one
or more Sustainability Impact objectivesof any sort (instead of or in addition tofinancial return).

1.2

In this annex certain underlying key
themes recur:

1.2.1

Generally, Asset Owners and Investment
Managers in Canada may only invest for
impact where such investments are inconformity with their existing obligations,which in most cases do not allow
Sustainability Impact objectives to takeprecedence over financial considerations.
Put another way, we do not think
Canadian law currently allows for Asset
Owners to Invest for Sustainability Impact
over financial objectives, absent specificauthorisation within the fund documents
or legislation.

223

ACKNOWLEDGEMENTS

1.2.2

1.2.3

1.2.4

The relatively narrow sub-set of Relevant
Investors empowered to Invest for
Sustainability Impact in priority toachieving stated financial objectives oninvestments are generally managers
of mutual funds where Investing for
Sustainability Impact is explicitly
authorised by the constating documents(as discussed further below).
In the absence of a specific mandate
allowing for, or directing, an Asset Owner
to prioritize IFSI alongside financial
returns, Relevant Investors face significant
hurdles in prioritizing IFSI. The complex
legal framework governing the activities
of Asset Owners and Relevant Investors isa significant obstacle to IFSI.
Notwithstanding the foregoing, it iswell established in Canadian law andpractice that Asset Owners may take
into account environmental, social,and governance (“ESG”) factors in theirinvestment decisions where relevant tofund performance. Moreover, ESG factors
are increasingly viewed as relevant to fundperformance,1 and the breadth and depthof ESG factors that are considered relevant
by Asset Owners has expanded greatly
over the past many years to include suchthings as measurable environmental
targets for portfolio construction,for example.2 In fact, a routine androbust consideration of ESG factors is
relatively common among large Canadian
institutional Asset Owners.3 While there
have been proposals to further facilitate
ESG investing (as described below at
2.2.24) there are currently no proposals
to change the law to specifically allow for
IFSI. However, where sustainability risks

such as climate change are determined
to be financially material to theperformance of an investment, and IFSI
approaches can be effective in helping toachieve an investor’s financial goals (i.e.
instrumental IFSI), there would likely be arequirement to consider using them andact accordingly, which may be especiallyrelevant in circumstances where there is alonger-term investment horizon.
1.2.5

Asset Owners in Canada are also sensitive
to the increase in regulatory disclosure
requirements and the need to increase
disclosure related to Sustainability Impact.
There is a growing recognition that theunderlying relationship between financeand the condition of society more broadly
requires a more thoughtful approach to
ESG factors.4 Support for the considerationof ESG factors exists both in Canadiansecurities law and in the principles ofCanadian fiduciary law. Consequently, tothe extent disclosure requirements impact
a Relevant Investor from a reputational
standpoint, such requirements may
incentivise IFSI so that Relevant Investors
can demonstrate that they are thinking
about such matters.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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2.

ASSET OWNERS’ USE OF POWERS OF INVESTMENT AND DIVESTMENT TO INVEST FORSUSTAINABILITY IMPACT

2.1

The following section considers the extent
to which and in what circumstances, eachtype of Asset Owner is (a) legally requiredor (b) legally permitted or able to use its
powers of investment and divestment toInvest for Sustainability Impact.

2.2

Pension Funds

be to provide a pension.10 Registration is
also required under provincial or federal
pension standards legislation. Pension
standards legislation establishes theminimum standards to which pension
plans must comply.
2.2.3

Types of pension fund covered
2.2.1

In Canada, a pension plan is typicallythought of as a plan “organized andadministered to provide a periodic
payment for life to an employee in
retirement.”5 There are two main features
to most pension plans, namely that:• “The plan contains provisions stating

how the pension and other benefits are
determined, together with the terms andconditions under which the benefits will
be payable (“design rules”); and2.2.4• Financial arrangements are made toprovide the funds needed when benefits
fall due, usually by building up assets in atrust fund or under an insurance contract(“funding rules”).”6
2.2.2

224

Pension plans which comply with thedesign rules applicable to a “registeredpension plan” (“RPP”) may be registeredunder the Income Tax Act (Canada)(“ITA”).7The ITA allows for contributions
to be remitted to the pension fund of an
RPP on a pre-tax basis, and exempts funds’
investment income from taxation.8 The
design rules prescribed by the ITA include
the maximum benefits an RPP may
provide and certain other rules to which
the RPP must adhere in order to retain its
tax-advantaged treatment.9 One such ruleis that the RPP’s primary purpose must

2.2.5

investment of plan assets is allocated bystatute to the administrator of the plan.
The person or body who administers an
RPP is generally identified in the plantext and must be one of an enumerated
list of persons or bodies identified
in the relevant minimum standards
legislation.14 In Quebec and Manitoba,
the administrator of an RPP is generally apension committee.15 The administrator
may delegate investment decisions
to an Investment Manager, however,
the administrator retains ultimate
responsibility for the investment of plan
assets and must monitor and evaluate
the Investment Manager and investment
performance. In many instances, the Asset
Owner and investment decision maker are
the same entity.

Canadian RPPs fall into one of two
broad categories, based on how they
are structured: defined benefit (“DB”)
or defined contribution (“DC”) pension
plans.11Historically, the majority of
RPPs were DB plans, and the majority ofCanadian assets under management withrespect to pension funds are still held undersuch plans. However, the past two decades
have seen a steady increase in DC plans.12
The term “pension fund” is used in thisannex to include pension funds, theinvestments of which are directed by anadministrator. Unless specifically statedotherwise, pension funds for which eachmember may direct the investment of hisor her account, including most defined
contribution pension plans and other capital
accumulation plans, are not included.
The key stakeholders are:
• Asset Owners: Canadian pension funds

are commonly established as trusts forwhich either a board or corporate trustee
is the trustee and legal owner of theassets, though certain large statutory
plans are established as corporations.13• Beneficiaries: The beneficiaries of an RPP

are the current and former employees
and retirees (and their spouses) who areentitled to receive a benefit from the plan.
• Investment decision maker: Decision-

making authority regarding the

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilOverview of investment duties and powers

Canada

2.2.6

China

Pension legislation in Canada imposes onplan administrators a “prudent person”
standard for the investment of plan assets,
which requires an administrator to apply
the level of prudence in dealing withpension assets as one would apply in dealing
with the property of another.16 The standard
is similar, but not identical, to the standard
imposed at common law on trustees toapply the level of prudence in dealing withtrust property as one would apply in dealing
with his or her own property – commonlyreferred to as the “ordinary prudence
standard”.17 Pension benefits legislation also
recognizes that certain tasks related to theadministration of the plan and fund may
be delegated to an Investment Manager.
Under some provincial legislation, delegates
become subject to the statutory standardof prudence.18

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2.2.7

2.2.8

2.2.9

While there are a number of cases inwhich administrators have been sued for
failing to adhere to the “prudent person”
standard, or in Quebec the “reasonable
person in similar situations” standard,
there is little discussion of the precise
content of either standard19, and no
discussion regarding the difference, if any,
between the standard articulated underpension legislation and that of “ordinary
prudence”.20 However, it is generally
accepted that the standard applicable
to a trustee would also apply to theadministrator of a pension fund.

plan administrator and pension plan
beneficiary in the management ofa pension fund. The fiduciary duty
owed to beneficiaries has also been
codified through legislation in all
minimum standards regimes acrossCanada.25Although Quebec civil law does
not recognize “fiduciary relationships”26
in the same manner as does Canadiancommon law, Quebec plan administrators
have fiduciary-like obligations to act ingood faith, with loyalty and in the bestinterests of the plan members which areoften termed “fiduciary obligations”.

The Supreme Court of Canada has
described the objective standard
applicable to a trustee as that of a manof ordinary prudence in managing his
own affairs, and this standard has been
applied equally to both professionals andnon-professionals. The court has noted,
however, that while the standard could berelaxed or modified, “a trustee’s primary
duty is preservation of the trust assets,
and the enlargement of recognized powers
does not relieve him of the duty of using
ordinary skill and prudence, nor from theapplication of common sense.”21

2.2.11 Under Quebec law, a pension committeethat is the administrator of a pension plan
acts as the trustee of the pension fund.27 In
Quebec, trustees are also regulated under
the Civil Code of Quebec (“CCQ”). Pension
funds which are established as trusts are
considered private trusts under the CCQ ,whose object is the erection, maintenance,and preservation of corporeal property
or the use of property appropriatedto a specific use.28 Trustees act as theadministrators of the property of others
charged with “full administration.”29
An administrator charged with full
administration must preserve the trust
property and make it productive, increase
the patrimony, or secure its appropriation
where the interest of the beneficiary or
the pursuit of the purpose of the trust
requires it and, in executing its duties, theadministrator must act with prudence anddiligence, and finally, the administrator
must also act honestly and faithfully in thebest interests of the beneficiaries or theobject pursued.30

In addition, the relationship between
plan administrators and plan members
is regarded as a fiduciary relationshipat common law.22 The Supreme Court of
Canada in Hodgkinson v. Simms23 recognized
three indicia of a fiduciary relationship,
namely (1) the ability to exercise somepower or discretion; (2) the ability to
exercise this power or discretion unilaterally
so as to affect the legal or practical interestsof beneficiaries; and, (3) a vulnerability to
the exercise of this power or discretion.24

2.2.10 All of the foregoing indicia characterize
the relationship between a pension
225

2.2.12 Some, though not all, pension statutes
expressly require that pension assets beinvested “in a manner that a reasonable

and prudent person would apply in respectof a portfolio of investments of a pension
fund.”31 It is generally accepted thatpension assets ought to be invested bearing
in mind “the overall reasonable level ofrisk the plan should undertake as a whole
and the appropriate level of diversificationof the entire pension fund.”32
2.2.13 Finally, pension funds are also subject
to modest but specific investment rules
set out in legislation that limit the way
pension fund assets may be invested(“Pension Investment Rules”).33 One
key Pension Investment Rule is therequirement to establish and adhere
to a statement of investment policies
and procedures (“SIPP”) for the pension
plan which discloses “what the plan will
invest in, how it will select, or terminate,
an investment manager, how it willmeasure performance, and what risks
are acceptable.”34 Regulatory guidance
similarly requires that a SIPP sets out
the administrator’s investment and risk
philosophy, and criteria to select, monitor
and replace managers.35
2.2.14 The SIPP must also disclose certain
information, including the administrator’s
policies and procedures with respect tocategories of investments, diversification,asset mix and expected rate of return,and liquidity, among others.36 As such,investments and Investment Managers
are generally selected so as to maximize
financial return within the specific asset mix
and risk tolerances articulated in the SIPP.
Legal requirements to use investment powers to
Invest for Sustainability Impact
2.2.15 No Canadian jurisdiction currently imposeson any trustee/administrator of a pension
plan a duty to Invest for Sustainability
Impact.37 Moreover, and as discussed below,

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

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United States

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while it is well-established that ESG factors
should be considered where relevant, there
is no support in any jurisdiction for theability of a plan administrator to Invest
for Sustainability Impact (i.e. to prioritize
ESG or sustainability factors ahead of thefinancial best interests of plan members).
In addition, it is unclear whether it isappropriate to consider IFSI on an equal
plane with economic factors in the absenceof express authority to do so unless thefinancial materiality of the sustainability
risks has been clearly established. Therefore,
without commenting on the appropriatenessof the Canadian regime, the legislative andcommon law regime is a significant obstacle
to the ability of a plan administrator toInvest for Sustainability Impact.
2.2.16 While there are proposals to further
facilitate the consideration of ESG factors,
as described below, there are currently no
proposals to change the law specifically toallow pension Asset Owners to Invest for
Sustainability Impact. However, proposedchanges to the ability of foundations
and non-profit organizations (“NPOs”) to
engage in certain investment practices(both discussed below at 2.2.24) areillustrative of potential changes and may
facilitate the movement toward IFSI for
NPO Asset Owners.38
2.2.17 Finally, disclosure rules, some of which
already exist, can be a very effectivemeans of encouraging Relevant Investors
to make investments and engage in
stewardship to encourage IFSI. Increasing
such requirements would likely increase
the reputational incentive for Relevant
Investors to demonstrate that they arethinking about IFSI.
2.2.18 Certain specific considerations warrant
further discussion.
226• Investing the Portfolio to Prevent Damage

to Sectors of Interest. To the extent
Sustainability Impact is relevant to thefinancial viability and appropriatenessof the investment, a plan administrator
would be required to consider it. As
noted above, the breadth and depth ofissues that may reasonably be considered
relevant has expanded in recent years toinclude a robust set of ESG-related factors.
The duty to consider such factors, where
relevant, is consistent with the prudent
person standard.
• Best Interests of Beneficiaries. There is

no statutory authority for trustees or
Investment Managers to consider thebroader, non-financial “best interests” ofbeneficiaries, and at least one Canadianpension statute explicitly requires thatplan assets be invested in the members’
financial best interests.39 Absent a statutory
mandate, Canadian law likely limits
the consideration of “best interests” tothose that relate to the duties of theadministrator – i.e. to provide a pension.
This is reflected in the overall approachto preparing the SIPP and the disclosuresrequired thereunder.
• Sustainability Aspirations of Beneficiaries.

In a DB plan, employees are guaranteed
a defined amount of pension on thebasis of a fixed formula for assessing
benefit entitlements.40 There is no duty
incumbent upon the administrator ofa DB pension fund to assess the viewsof Beneficiaries in executing on suchpromise. Similarly, no such duty exists
for the administrators of administratordirected DC pension funds, which like DBplans, rely on the administrator of theplan to establish the investment policy
and to select and monitor investments.41

There exists, however, a second form of
DC plan which is commonly referred to asa member-directed DC plan. This type ofplan is discussed further below at 2.2.29.
• Seeking Wider Societal Objectives. There is

no requirement for pension funds to set
objectives for increasing the positive and/or reducing the negative Sustainability
Impact of their portfolios, nor would it
be consistent with the legal frameworkas it currently stands to do so in priority
to plan administrator’s stated financial
objectives. However, as noted above, wherewider societal objectives are relevantto the administrator’s stated financial
objectives, they must be considered.
Further, certain regulatory requirements
related to the maintenance of the SIPP
may cause the administrator to disclose
an objective of achieving a Sustainability
Impact. Each year, fund administrators
must review and either confirm or
amend their SIPP with respect to theassets held by the fund. In Ontario,
additional regulations obligate RPPs
to ensure the plan assets are always
invested in accordance with the SIPP. As
a result, the SIPP must be amended prior
to the implementation of any change
in investment policy. Thus, while not
an explicit requirement to disclose theimpact on the portfolio, this requirement
would likely oblige any fund which has
an objective of achieving a Sustainability
Impact to report the same in its SIPP, andto amend such disclosure in the case it
should no longer pursue such goals. Thisrequirement, however, is entirely reliant
on the fund administrator setting a nonfinancial goal, which will inevitably beprioritized below the financial interests ofthe fund – i.e. to fund the plan.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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Legal freedom to use investment powers to Invest for
Sustainability Impact
2.2.19 There is no express legal impediment
preventing trustees from assessing
the views of Beneficiaries withrespect to Investing for Sustainability
Impact.42However, they may be
prevented from reflecting those viewsin the objectives of the portfolio if theseobjectives are incompatible with or
purport to take precedence over applicablestatutory objectives (usually found inpension and/or tax legislation) or over
the objectives/purposes of the fund inquestion under its constitutive document.
2.2.20 It is well established that Asset Owners
may take into account ESG factors in theirinvestment decisions where relevant tofund performance objectives or where thetrust instrument explicitly permits theuse of non-financial criteria.43 Moreover,
ESG factors are increasingly viewed as
relevant to fund performance, and thebreadth and depth of ESG factors thatare considered relevant by Asset Owners
has expanded greatly over the past many
years to include such things as weather
events, water scarcity, carbon emissions,diversity and inclusion, health and safety,
consumer protection, clarity of board
mandates, executive compensation, andboard independence.44 In fact, a routine
and robust consideration of ESG factors is
relatively common among large Canadian
institutional Asset Owners.45
2.2.21 Notwithstanding the foregoing, and as
noted above, we do not think that the law in
Canada has evolved to allow pension Asset
Owners to IFSI above fund performance
objectives for the following reasons:• First, as noted above, the legislative

framework governing pension plan
227

administrators codifies the common law
fiduciary duties of trustees. At common
law, trustees must invest assets consistent
with the financial best interests ofbeneficiaries. So too must pension plan
administrators and, as noted above, someCanadian pension legislation expressly
requires that plan assets be invested in themembers’ financial best interests.46• Second, minimum standards legislation

directs the administrator to invest plan
assets with a view to ensuring promised
pension benefits are paid. Subject to the
singular exception at 5.2.1, applicablelegislation authorizes no other objective.
• Finally, just as trustees are enabled by

the trust deed and the powers contained
therein, pension plan administrators areenabled by plan documents which must,
according to tax rules, set out that the
primary purpose of an RPP “is to provide
periodic payments to individuals after
retirement and until death in respectof service as employees.”47 Investingplan assets with some other purpose
is arguably inconsistent with that
requirement. We are therefore of theview that a Relevant Investor pension
plan administrator cannot exercise its
discretion in a manner that does not
relate to the purpose of the fund – thatbeing to provide promised pensions tomembers. This fiduciary obligation to
the beneficiaries of the plan extends
to trustees and Investment Managers
retained to manage fund investments.48
2.2.22 Given the foregoing, we think that specificpermission within the pension statutes
to consider IFSI on an equal plane or inpriority to financial considerations would
be required for trustees and Investment
Managers to engage in IFSI. No suchstatutory permission exists, though
Manitoba’s pension and trust legislation
does warrant some discussion.
2.2.23 Interestingly, in Manitoba, the Trustee Act(Manitoba) contains a unique provision
which states: “Subject to any express
provision in the instrument creating thetrust, a trustee who uses a non-financial
criterion to formulate an investment
policy or to make an investment decision
does not thereby commit a breach of trust
if, in relation to the investment policy orinvestment decision, the trustee exercises
the judgment and care that a person ofprudence, discretion and intelligencewould exercise in administering theproperty of others.”49 A similar provisionauthorizing the use of non-financial
criteria in formulating an investment
policy is found in the Pension Benefits Act(Manitoba).50 To date, no other Canadianjurisdiction has adopted analogous
provisions and neither provision has beentested in court. Given the requirement toconsider non-financial factors while still
adhering to the standard of prudence, it is
not clear whether or not IFSI is permitted
for plan administrators and trustees;
however, a reasonable case could bemade for allowing IFSI to be the deciding
factor, all else being equal. Of course,
authorization for such an approach would
have to be supported by the applicablefund documents.
2.2.24 At this point, it is also potentiallyinstructive to briefly consider the abilities
of charities and NPOs to IFSI.51 Under
Canadian law, a charitable organizationmust have purposes which are exclusively
charitable, and these can fall within
one or more of (1) the relief of poverty,(2) the advancement of education, (3)ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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FranceJapan

Netherlands

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the advancement of religion, or (4)certain other purposes that benefit
the community, which purposes alignsubstantially with the UN Sustainable
Development Goals (“SDGs”).52 Similarly,
many NPOs are organized and operated
for social welfare or civic improvement(although any purpose that is not that ofprofit is permissible).53 As such, charities
and NPOs can be important driving forcesin the movement towards IFSI.
• In theory, charitable property falls

under the exclusive jurisdiction of
Canadian provinces. However, the federal
government maintains significant control
over charities through the ITA.54 The ITA
defines three types of registered charities,
namely charitable organizations, public
foundations, and private foundations.55
The ITA and related guidance from the
Canada Revenue Agency (“CRA”) can“often inhibit the ability of charities [to]participate in revenue generating andcapital activity” thereby preventing suchorganizations from fully participating informs of IFSI.56• Under the current provisions of the ITA,

limitations on charitable expenditures
prevent charities from investing in NPOs,
co-operatives, social purpose or hybridbusinesses, or impact investment funds,
where returns risk being below market
rate. While investments may be madeon market terms subject to prudent
investment standards, investments
yielding below-market returns may only
be made in so-called qualified donees orin non-qualified donees57 to the extent
that the latter are subject to the ongoing
control and direction of the charity.58
These restrictions limit the potential forcharities to IFSI.
228• In 2017, Bill 154 amending the Charities

Accounting Act was passed in Ontario in an
attempt to grant charities the capacity
to IFSI. The amendments provide that
directors and trustees of charities may
IFSI subject to any restriction containedin their governing documents.59 Suchinvestments are no longer subject tothe prudent investor standard. Instead,directors or trustees IFSI are required
to abide by the following: first, before
making the investment, they must be
satisfied that it is in the best interestsof the charity. Second, before making
the investment, they must seek advice
as needed. Finally, after making theinvestment, they must review it from time
to time and seek advice with respect tosuch reviews as needed.60• Unfortunately, it is unclear how theseprovincial regulations interact with the
ITA rules outlined above. Given the severe
consequences for charities that fail tocomply with the investment framework
permitted by the ITA, including the lossof assets and the potential stripping of
their charitable designation, there is little
incentive for charities to act on theseamendments to IFSI.61 One means by whichcharitable foundations may IFSI is throughdebt financing to NPOs and social-purpose,
for-profit organizations. Many foundations
achieve this by investing “through a thirdparty impact fund or capital program”
since direct investments are often
considered impossible.62• Much like charities, NPOs fall undershared federal/provincial jurisdiction
in Canada.63 NPOs are prohibited fromhaving any profit earning purposes.64
However, a 2014 report published by the
CRA found that “many in the non-profit

sector believe that NPOs must produce
a profit for their programs to thrive andfor their capital assets to be maintained”
and further that “there is a common view
that, as long as profits are used to further
the organization’s purpose, the source ofthe funding shouldn’t matter.”65 Despite
its findings, the CRA has issued conflicting
guidance, stating on the one hand thatan NPO may earn profit where it isincidental to and results from activities
which support its stated objectives, andon the other hand that if an NPO intends
at any time to earn a profit it shall lose its
tax exempt status, regardless of whether
the profit was used to support its statedobjectives or not.66 These restrictions limit
the growth and potential impact that
NPOs may have on the IFSI landscape.
2.2.25 As such, unlike the Manitoba Trustee Act
and Pension Benefits Act, investments under
the Charities Accounting Act (Ontario) are
no longer subject to the prudent investor
standard. Nevertheless, such entities are
restricted in their investment activities
by the ITA. Therefore, although Asset
Owners such as pension plans may
be empowered to consider IFSI, otherregulatory frameworks applicable to
the Asset Owner, such as the ITA may
circumscribe any such powers (including
under the Manitoba Trustee Act and Pension
Benefits Act).
2.2.26 In the absence of specific statutory
authority to consider IFSI, Canadianscholarship on the subject has exploredthe permissibility of considering nonfinancial criteria in making investment
decisions for pension funds, particularly
in light of the uncertainty stemming fromthe 1984 UK decision in Cowan v. Scargill
which has long been cited in support

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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CONTENTSFOREWORDSINTRODUCTIONof the proposition that a “trustee must
not select speculative or unduly risky
investments … [and] trustees are not toinvest on the basis of political or social/economic belief.”67
2.2.27 We acknowledge that there is anincreasing recognition that the concept of
the fiduciary is not static and that there
is a need to “take a longer term and more
systemic view of fiduciary obligations.”68
Considerations such as market integrity,
systemic risk, governance risk, and soon, which have a bearing on the longer
term viability of funds and therefore
upon future generations of beneficiaries,
are beginning to become more present
in public discourse.69 Indeed, the abilityof funds to continue to provide forbeneficiaries is intimately tied to theoverall health of the market, as funds holddiversified portfolios which tend to track
the market as a whole.70 Further, it haslong been accepted that the considerationof non-financial criteria as risk factors –for example, in the context of ESG factors– is permissible.
2.2.28 However, neither Canadian jurisprudence,
nor Canadian legislation outside of Manitoba(and the Ontario Charities Accounting Act), has
explicitly considered whether a “valuesbased” approach to investing is equallypermissible.71 Commentators have called into
question the authority of Cowan v. Scargill,citing a series of cases stemming from boththe United States and the United Kingdom
which seemingly contradict its conclusions.72
What may be suggested by thesedevelopments is that fiduciary trustees havea duty not necessarily to maximize returns inthe short term, but rather to “set investment
policy with a reasonable expectation thatthe portfolio will achieve a reasonable rate229

of return over the long term that satisfies
the individual pension plan’s funding
requirements while minimizing risk througha portfolio-based investment approach.”73
Yet, given the lack of a clear legislated
standard and the lack of direction from
Canadian courts, it is likely that pension
funds will maintain a more conservative
approach to investing which may not extend
beyond existing ESG practices.
2.2.29 Finally, it has been suggested that it ispossible for certain pension plans (i.e.,
member-directed plans) to IFSI.74 Under amember-directed DC plan, the amount ofcontribution for each of the employer andthe employee is specified; however, it is
the members who ultimately decide how
to invest their own contributions, as wellas those of their employer. In the context
of such plans, the administrator may opt
to provide a selection of funds that are
IFSI which members may then choose
to invest in. The Canadian Authority ofPension Supervisory Authorities (“CAPSA”)
publishes guidelines with respect to fundadministration and it has issued guidance
specifically with respect to the selectionof investments for members of DC plans.
Per the guidelines, administrators must
consider “all relevant factors” in selecting
investments, including a consideration of thenature of the investment and its risk return
profile.75 Relevance, however, is still related
to the primary purpose of the pension plan(i.e. to provide pensions). As such, we think it
is in keeping with the administrator’s duties
to select and offer funds that allow members
to build a reasonably diverse portfolio
appropriate for retirement savings and to
consider the same relevant factors as would a
DB plan administrator.

2.3

Mutual funds

Types of mutual fund covered
2.3.1

2.3.2

In this section, we consider mutual funds
that are offered to retail investors undera “simplified prospectus”, as detailed
below, and that are “reporting issuers”
in a jurisdiction in Canada to be themost common form of regulated mutual
funds in Canada. We exclude other typesof investment funds, such as alternative
mutual funds76 and exchange-tradedmutual funds (i.e. ETFs),77 as well as otherretail investment funds and quasi-retailfunds, such as non-redeemable investment
funds (i.e. closed-end funds), flow-throughfunds, labour sponsored investment funds,
scholarship plans, and private mutual/
investment funds.
Mutual funds are pooled investment
vehicles that issue securities on acontinuous basis and are generally
redeemable daily by reference to their
net asset value (“NAV”).78 Mutual funds
in Canada are typically structured astrusts and corporations. A mutual fundwill often have a specific focus on a typeof underlying investment (i.e. equities,
bonds), geography (i.e. emerging markets,
Europe), some other investment theses (i.e.
small cap companies, dividend growth,socially responsible investment, etc.) or
some combination of the foregoing (i.e. U.S.
small cap companies, Canadian dividend
growth, etc.).79 While mutual funds can beeither actively or passively managed, they
are generally actively managed in Canada.
Some of the more prevalent categories ofmutual funds in Canada include equities,
bonds, small/large cap business and money
market funds.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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2.3.3

2.3.4

230

Mutual funds in Canada are regulated at theprovincial level by the securities regulatory
authority of each province and territory.80
However, securities regulation is largely
harmonized across jurisdictions throughrules known as national instruments (“NIs”)
or regulations in Quebec.81 Mutual funds in
Canada are subject to several NIs.82 In order
to sell securities to the public, NI 81-101(Mutual Fund Prospectus Disclosure), requires
the investment fund manager (“IFM”) of amutual fund to file a simplified prospectus,
an annual information form, and “fundfacts” for every class or series of the mutualfund (the “Regulatory Disclosures”).
The IFM must periodically, and not lessfrequently than annually, review and re-file
Regulatory Disclosures and revise them as
needed to reflect material changes that are
relevant to the disclosures.83
Every mutual fund must have an IFM who
is registered under applicable Canadiansecurities laws in the relevant category.
The IFM is responsible for the day-to-day
management of the mutual fund; however,a mutual fund’s investment decisions must
be made by a firm that is registered underapplicable Canadian securities laws in the
category of portfolio manager (“PM”). The
IFM may also be the mutual fund’s PM, but
the PM function is sometimes outsourced
to an affiliated or third-party firm. Finally,mutual funds may only be distributed
to investors that are registered in an
applicable category of dealer (“Registered
Dealers”). Most of Canada’s provincial andterritorial securities regulators delegate
significant aspects of the licensing processof Registered Dealers to self-regulatoryorganizations, mainly the Mutual Funds
Dealers Association (“MFDA”), which

oversees registered “mutual fund dealers”
and the Investment Industry Regulatory
Organization (“IIROC”), which overseas
registered “investment dealers”.84
2.3.5

This fiduciary duty, however, does notextend to mutual fund beneficiaries(securityholders); it is the mutual funditself that owes duties to beneficiaries.
The IFMs’ investment duties and powers
are also shaped by the mutual fund’s
constating documents drafted when themutual fund is set up.

The key stakeholders are:
• Asset Owner: The mutual fund (in theform of its trustee or body corporate)is the owner of the underlying assets;
however, the mutual fund assets mustbe held separately by a qualified thirdparty custodian. The custodian must meetcertain requirements that are set out
under applicable Canadian securities law
and is usually a subsidiary of a charteredbank or a trust company.85 The IFM cannot
act as custodian.

2.3.7• Beneficiaries: The beneficiaries ofa mutual fund are the beneficial
securityholders (also called unitholders)
under the fund.
• Investment decision-maker: The PM is

the investment decision-maker. The IFM,
if registered as a PM, may act as a mutual
fund’s PM or delegate the investment
management functions to another PM(whether a third-party or an affiliate). A
PM may further delegate all or a portionof the investment decisions in respect ofa mutual fund’s portfolio to a sub-advisor(such sub-advisor must itself be registeredas a PM or exempt from the registration
requirements).

2.3.8

Overview of investment duties and powers
2.3.6

An IFM is generally subject to a fiduciary
duty at common law and is required to act
in the best interests of the mutual fund.86
As a fiduciary, an IFM must prudently
manage the portfolio, including informing
themselves and considering all risk
management and portfolio techniques.87

2.3.9

Where the IFM has appointed a separate
PM, the PM is typically subject to a similar
standard to act in the best interest of
the mutual fund under the terms of theinvestment management contract. A PM
is also subject to requirements underapplicable Canadian securities lawswith respect to its dealings with clients(including mutual funds for which it
manages investments). We note that
although Registered Dealers are not subject
to a fiduciary duty with respect to theirclients, they still have a duty to act fairly,
honestly, and in good faith with clients.88
Registered Dealers are subject to“Know Your Client” (“KYC”) and “KnowYour Product” (“KYP”), as well assuitability requirements that serve to“ensure that purchases of securities
are not incompatible with the client’s
circumstances, risk tolerance andinvestment goals.”89 Under theserequirements, dealers must engage in aprocess of due diligence on the proposed
investment based on a series of factors
including clients’ investment needs andobjectives, their financial circumstances
and their risk profile.90
Under NI 81-102 (Investment Funds), mutual
funds are subject to standard investment
restrictions designed to ensure that themutual funds are diversified, minimize
certain risky practices and maintain

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sufficient liquidity to meet redemption
needs.91 The principal restrictions include:• Concentration Restriction: no more than

10% of the NAV of the mutual fund can bein the securities of any one issuer, subject
to certain exceptions;• Control Restriction: no more than 10%of the securities of any single class of anissuer can be held by the mutual fund;• Asset Prohibitions: no investment inreal property, mortgages (other thanguaranteed mortgages), commodities(exemptions for certain precious metals),or loan syndications;• Commodity Restrictions: no more than 10%of the NAV of the mutual fund can be madeup of gold, silver, palladium, platinum orother precious metals (exceptions exist for“precious metal funds”);• Illiquid Asset Restrictions: an asset cannot

be purchased if it causes “illiquid assets”(as defined in NI 81-102) owned by themutual fund to exceed 10% of the NAV of
the mutual fund; and• Other restrictions on the compositionof underlying fund holdings, use ofderivatives and borrowing capabilities.92
2.3.10 These restrictions are intended tofurther the proposition that mutual funds
should preserve an investor’s right toredeem on demand, while at the sametime allowing mutual funds to be offeredwith more narrow investment objectives
than are typically offered by otherinvestment products.93
Legal requirements to use investment powers to
Invest for Sustainability Impact
2.3.11 We do not consider that IFMs are
generally subject to any duty to Invest

231

for Sustainability Impact, althoughwhere sustainability risks are financiallymaterial, the consideration of IFSI
approaches may be appropriate. We
further note that to the extent the IFM’sfund instrument requires non-financial
factors to be considered in making
investments, adopting a passive or
quantitative strategy may be incompatible
with the duty to account for such factors.
2.3.12 IFMs, as discussed above, have a fiduciary
duty to act in the best interests of the fund.
As their duty is not to securityholders/
Beneficiaries, it follows that there is nolegal requirement for IFMs to assess theviews of mutual fund Beneficiaries on theextent to which they want their assets
managed to achieve an impact. Similarly,
the duties and powers of Relevant Investors
under Canadian law do not impose any
requirement to structure a portfolio byreference to IFSI rather than or in addition
to achieving a return on investment.
2.3.13 However, many mutual funds aremarketed with reference to specificinvestment objectives, including IFSI
(as discussed below). In such cases the
IFM would be expected, and in a general
sense, legally required, to invest fundassets in a way that conforms with therepresentations made to unitholders.
2.3.14 Further, while Registered Dealers areunder no general obligation to inquire intoclients’ views on IFSI, where the fund they
are marketing states IFSI as its investment
objective (discussed at 2.3.18), it follows thatdealers will have to inquire into such viewsin order to satisfy the KYC requirements
and determine whether the investment
is suitable for the client. To this extent,interested clients should be able to accessappropriate impact vehicles through their
Registered Dealers.94 Indeed, a growing
number of bond funds, mutual funds, andETFs are facilitating – to an extent – thechannelling of private capital toward IFSI.95
Legal freedom to use investment powers to Invest for
Sustainability Impact
2.3.15 Mutual funds may be set up to Invest for
Sustainability Impact. While NI 81-102
imposes certain fundamental standard
investment restrictions, as discussed
above, these investment restrictions in noway prohibit a mutual fund from adopting
an investment objective or investment
strategy that is geared towards IFSI. For
example, Morningstar reported the launchof over 60 such funds in Canada in thepast five years, including 11 as of thefirst quarter of 2020, available to both
retail and institutional investors throughfinancial institutions, asset management
firms and credit unions.96 We would
expect that any mutual fund IFSI would
adopt a “Fundamental Investment
Objective” (see below) and tailor its
investment strategies in each case as
disclosed in the Regulatory Disclosures,such that the mutual fund commits to
IFSI. In these circumstances, the approvalof the majority of unitholders would be
required to alter the specific investment
objective of a fund.97
2.3.16 Also, while there is no explicit requirement
for mutual funds to set objectives forincreasing the positive and/or reducing thenegative impact of their portfolios, Form
81-101F1 (Contents of Simplified Prospectus)
imposes specific disclosure requirements
in respect of a mutual fund prospectus(which is required to issue and sell units).
The mutual fund prospectus, as well as

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
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other Regulatory Disclosures, must be
revised to reflect any material changes
and must also be updated (renewed)
annually for the mutual fund to remain
in continuous distribution.98 Among these
disclosure requirements, the fund must
disclose its “Fundamental Investment
Objectives” meaning that it must disclose“the fundamental investment objectivesof the mutual fund, including informationthat describes the fundamental natureof the mutual fund, or the fundamental
features of the mutual fund, that
distinguish it from other mutual funds.”
A mutual fund that seeks to Invest for
Sustainability Impact (and to market itself
to potential investors as doing so) would be
required to state such objective as one ofits “Fundamental Investment Objectives”.
As mentioned above, a mutual fund may
not change its “Fundamental Investment
Objectives” without the prior approvalof securityholders.
2.3.17 A mutual fund must also disclose theinvestment strategies that will be used
to achieve the disclosed investment
objectives in Regulatory Disclosures. This
includes disclosure about “the process bywhich the mutual fund’s portfolio advisor
selects securities for the fund’s portfolio,
including any investment approach,philosophy, practices or techniques usedby the portfolio adviser or any particular
style of portfolio management that theportfolio advisor intends to follow.” Again,
while such disclosure does not amountto an explicit requirement to disclose theimpact achieved by the mutual fund, it
does constitute a requirement for thesemutual funds to disclose their investment
policies and goals, including IFSI-related
goals, if any.
232

2.3.18 IFMs and PMs that are managing mutual
funds marketed as IFSI must consider
Sustainability Impact when making all
investment decisions, consistent with
the Regulatory Disclosures provided toinvestors. IFMs/PMs that are managing
mutual funds that are not marketed as IFSI
may consider Sustainability Impact where
it is financially beneficial or where it ispermitted by the constating documents,and may select such investments overtraditional investments all other factors
being equal. However, to the extent
IFMs/PMs of such “non-IFSI funds” wereto prioritize Sustainability Impact tothe detriment of the financial returns
achievable by the mutual fund, such
IFMs/PMs could be subject to causes ofaction from investors and/or enforcementfrom regulators. Nevertheless, where
IFSI investments align with the duties of
Relevant Investors, these will be permissible,
as long as IFSI objectives are not taking
precedence over financial returns.
2.3.19 Ultimately, under certain circumstances
IFMs/PMs may Invest for Sustainability
Impact where these investments are inconformity with their general obligations
toward investors. In the case of certain
mutual funds, IFMs/PMs must Invest
for Sustainability Impact in conformity
with representations made in the mutual
fund’s Regulatory Disclosures, where thisdisclosure reflects IFSI as a fundamental
investment objective of the mutual fund.
2.4

reinsurance) companies/societies carrying
on business in Canada. These companies/
societies may be incorporated/formed
under federal Canadian law or provincial
Canadian law, or instead outside Canada
and carrying on business in Canada on alicensed branch basis.
• Asset Owner: Insurer.
• Beneficiaries: Policyholder entitled tobenefit from the policy and shareholders.
• Investment decision maker: Insurer ordelegated investment manager.
Overview of investment duties and powers
2.4.2

2.4.3

Insurance undertakings

Types of insurance undertaking covered
2.4.1

Life and health insurance/reinsurancecompanies/societies and generalinsurance/reinsurance (in Canada,called property and casualty insurance/

2.4.4

Insurance companies are prudentiallyregulated by the Office of theSuperintendent of Financial Institutions(“OSFI”) if incorporated federally or
carrying on business in Canada as abranch of a foreign company, or by aprovincial Superintendent of Insurance if
incorporated provincially.99 The prudential
regulators are responsible for the
regulation of the “solvency and financial
soundness” of insurance companies
incorporated in their jurisdiction (orin the case of OSFI, foreign companies
carrying on business in Canada on abranch basis).100
Insurance companies are subject to astatutory prudent person standard in
relation to the investment of their assets,
as well as numerous specific regulatory
requirements and guidelines. Notably,
however, insurance companies are notfiduciaries for their policyholders in respectof the investment of company assets.
Federally incorporated insurers and foreign
branches are subject to certain constraints
on investment under the Insurance Companies
Act101 (Canada) (“ICA”) and OSFI Guidelines.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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BrazilCanadaChina

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FranceJapan

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Generally, their lending policies andprocedures must be such as “a reasonable
and prudent person would apply in respectof a portfolio of investments and loans
to avoid undue risk of loss and obtaina reasonable return.”102 The provincial
regulators impose similar restrictions onprovincially incorporated insurers. These
restrictions, however, do not impose or giverise to a fiduciary duty of the insurancecompany toward the insured as relates tothe management of their investments.
2.4.5

2.4.8

We also note that insurers have general
duties to treat customers fairly and to
avoid unfair or deceptive acts or practices
in their dealings with the policyholder.
Further, unless the terms of the policy
documentation are specifically related
to IFSI, there are generally no relevant
insurance fund obligations or duties thatarise because of the terms of the policy
documentation that the insurer hasentered into with its policyholders.103

General insurance: Legal requirements to use
investment powers to Invest for Sustainability Impact
2.4.6

2.4.7

233

There are generally no situations in whichit could be suggested that general insurers
have a duty to exercise investment powers
for IFSI in priority to financial return.
More specifically, there are no legal
requirements for insurance companies toassess the views of policyholders on theextent to which they want the company’s
assets managed to achieve a Sustainability
Impact or to set objectives for increasing
the positive and/or reducing the negative
Sustainability Impact of their portfolios.
While insurers must make investments inaccordance with a statutory standard ofprudence, this does not amount to a fiduciary

duty toward policyholders and as such does
not impose a duty to take into account the
Sustainability Impact of such activities.

to shareholders and regulators, insurancecompanies are unlikely to prioritize IFSI
over financial return.

Wider Societal Objectives & Community
Development. We do note, however, that
under the ICA, Canadian federal insurers
with equity of $1 billion or more must
annually publish a Public Accountability
Statement (“PAS”).104 This statement
describes the company’s contribution
to the Canadian economy and society.
The statement must provide detail withrespect to, among other things, thegoals of the company and its affiliates in
the area of “community development”(defined to mean the social, cultural,
economic or environmental enrichmentof a community), and participation in
activities for the purpose of community
development, including the making offinancial contributions for that purpose.105
As such, any Sustainability Impacts of theportfolio would presumably be disclosed,
but this disclosure requirement in no way
requires Investing for Sustainability Impact.

(a) Insurers are subject to a legislated prudent
person standard. The ICA, which regulates
federally incorporated insurers andlicensed foreign insurers, provides thatfunds shall be invested in accordance with“investment and lending policies, standards
and procedures that a reasonable andprudent person would apply in respect of aportfolio of investments and loans to avoid
undue risk of loss and obtain a reasonable
return.”107 Similar requirements exist at
the provincial level across Canada.108 This
language suggests that insurers are not atliberty to make investments which prioritize
Sustainability Impact over and above
financial returns, though as above, where
an investment can achieve Sustainability
Impact and also promise a return on
investment consistent with the obligation
to invest in view of obtaining a reasonable
return, there is nothing to prevent an
insurer from making this investment.

General insurance: Legal freedom to use investment
powers to Invest for Sustainability Impact
2.4.9

Even though the applicable legal rules
and policy documentation do not resultin obligations to Invest for Sustainability
Impact, there are circumstances inwhich they are flexible enough to allow
an insurance undertaking to use its
investment powers to pursue IFSI.

2.4.10 We note at the outset, however, that while
not precluded by law or regulation, it
is unlikely that an insurance company
would be set up to Invest for Sustainability
Impact.106 As commercial entities in ahighly competitive industry answerable(b) Further, directors in Canada do not owe afiduciary duty to their shareholders, butrather owe such a duty to the corporation
itself.109 Therefore, directors must act
honestly and in good faith, with a viewto the best interests of the corporation,
which, given the competitive nature of
the industry, are unlikely to align with aninvestment strategy which prioritizes IFSI
over return on its investment.
2.4.11 The Supreme Court of Canada, on theother hand, has suggested some openness
to broadening the fiduciary duty, as it
stated in its decision in BCE Inc. v 1976
Debentureholders (“BCE”) that directors are

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B. THE EXTENT TO WHICH
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under a duty to “act in the best interestsof the corporation viewed as a good corporate
citizen” (emphasis added) and it has beenargued that such an understanding“furthers the broader social purpose offiduciary duties by requiring fiduciaries
not to undertake unethical actions thatwould shake public confidence and trust in
fiduciaries and the services they provide.”110
Whether this in turn would permit
directors to engage in IFSI remains an open
question. We note that even if it did, BCE
would not alone pave the way for insurers
to engage in IFSI given the legislative
standard of prudence imposed on insurers.
2.4.12 It is also worth noting that in 2019, thefederal government passed Bill C-97 which
introduced amendments to the CBCA
codifying the decision of the Supreme Courtof Canada in BCE. Per Section 122(1.1), whenacting with a view to the best interests ofthe corporation, directors (and officers)
must consider the following non-exhaustive
list of factors, which include (1) the interestsof shareholders, employees, retirees andpensioners, creditors, consumers andgovernments; (2) the environment; and (3)the long-term interests of the corporation.
Comparable amendments have not been
proposed to the statute under which
Canadian federal insurance companies areincorporated/regulated.
Life insurance: Legal requirements to use investment
powers to Invest for Sustainability Impact
2.4.13 There are generally no situations in whichit could be suggested that life insurers
have a duty to exercise investment
powers for IFSI in priority to financial
return. The same commentary/analysis
applies as in respect of general insurers234(as described above), although investment
portfolios of life insurers would typicallybe oriented more to long-term investment/
performance, given the much longerterm nature of life insurance companies’
products/obligations.
Life insurance: Legal freedom to use investment
powers to Invest for Sustainability Impact
2.4.14 The same commentary/analysis applies
as in respect of general insurers (asdescribed above).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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3.

ASSET OWNERS’ USE OF THEIR POSITION TO ENGAGE IN STEWARDSHIP ACTIVITIES TO SECURESUSTAINABILITY IMPACT

3.1

The following section considers the extent
to which, and on what basis, each typeof Asset Owner is (a) legally required or(b) legally permitted or able to use its
position to influence enterprises in which
it invests by engaging in stewardship
activities designed to achieve positive
sustainability outcomes and minimise
negative sustainability outcomes.

3.1.4

Overarching Considerations
3.1.1

3.1.2

3.1.3

235

For pension funds, insurance companies
and most mutual funds, it is unlikely thateither the prudent person standard, or,where applicable, the fiduciary standard,
would require a Relevant Investor to
engage in non-financial stewardship
activities. Nor are there regulatory
obligations that would require suchstewardship. Reputational considerations
with respect to being perceived as a good
economic actor may encourage Relevant
Investors to engage in stewardship
activities notwithstanding that there is noclear legal duty to do so.111
The various disclosure obligations
discussed in Section 2 would not give rise
to a duty to engage in stewardship, except
in the indirect sense that there would be
an obligation to make reasonable efforts
to obtain accurate information so as
to discharge the disclosure obligation.
Similarly, there would be no duty todivest, or liability for a failure to divest.
Liability is discussed further in Section 7.
Also, strategies can be adopted under
existing Canadian law to engage withbusinesses to promote responsible practices.
For example, investors may, under therules of the CBCA or any of the provincial

3.1.5

Business Corporations Acts, file shareholder
resolutions or vote proxies guided byenvironmental and social concerns.112

3.2

A survey of over 100 asset managers/
owners in Canada found that among
respondents, 55% of organizations had,in 2018, adopted a formal policy onshareholder engagement.113 Further,
71% of respondents reported publishingformal proxy guidelines with respect toresponsible investment practices, and 60%
opted to publicly disclose their proxy voting
results.114 These results suggest a robust
practice of shareholder engagement among
investors and that investees are responsive
to this changing landscape.

3.2.1

Finally, while we are not aware of any
Sustainability Impact disclosure standards
being set within Canada, Asset Owners
in Canada are nonetheless sensitive tothe increase in regulatory disclosure
requirements and the need to increase
disclosure related to sustainability and
it is likely that several will consider
international guidance such as the
Global Reporting Initiative (“GRI”)
Sustainability Reporting Guidelines,
the International Integrated Reporting
Council Integrated Reporting Framework(“Integrated Reporting Framework”),
and/or the Sustainability Standards Board
Standards.115 In Canada, 119 organizations
registered their sustainability reports with
the GRI in 2017, a substantial increase
from only 47 in 2008. In contrast, very
few were found to use the Integrated
Reporting Framework.116

Pension funds

Legal requirements to engage for
Sustainability Impact
As mentioned, it is unlikely that either theprudent person standard, or the fiduciarystandard, would require a Relevant
Investor to engage in non-financial
stewardship activities unless the rationale
for doing so relates to the long-term
financial viability of the investment. Nor
are there regulatory obligations thatwould require such stewardship, unless
prudence would suggest that doing sowould enable or improve the long-term
financial viability of the investment.

Legal freedom to engage for Sustainability Impact
3.2.2

3.2.3

Relevant Investors are permitted toencourage investee companies to adopt
practices that enhance long-term financial
performance and would generally beaccorded flexibility to encourage positive
Sustainability Impact. There is empiricalevidence that companies with good trackrecords on ESG issues tend over the longterm to outperform companies in thesame industry with poor performance on
ESG issues.117
The Canada Pension Plan Investment
Board (a public sector pension fund, the“CPPIB”) Policy on Sustainable Investing
includes the following among its guiding
principles: “Responsible corporate
behaviour with respect to ESG factors
can generally have a positive influenceon long term financial performance”
and “Employees, customers, suppliers,
governments and the community atlarge have a vested interest in positive
corporate conduct and long-term business

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B. THE EXTENT TO WHICH
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BrazilCanadaChina

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performance”.118 Similarly, the CPPIB
Proxy Voting Principles and Guidelines statethat proxy voting is a key element in its
approach to sustainable investing, and“[as] an owner, we monitor ESG factors
and actively engage with companies topromote improved management of ESG,
ultimately leading to enhanced long-term
outcomes in the companies and assets inwhich we have a stake.”119 Increasingly,
industry associations, such as the
Canadian Coalition for Good Governance,are encouraging members to recognizethat Sustainability Impacts can bematerial to a company’s long-term value.
3.2.4

3.2.5

236

The Colleges of Applied Arts andTechnology (“CAAT”) Pension Plan’s
Responsible Investing Policy provides
that the CAAT Plan will vote the proxies
attached to its shareholdings thoughtfully
and responsibly, and that shareholder
proposals dealing with ESG factors will be
examined considering the effects of the
proposals on shareholder value. According
to the CAAT Pension Plan, votes are
generally cast in favour of proposals that
corporations adopt policies that embrace
the International Labour Organization’s
Conventions, the Ceres Principles on theEnvironment, and the Organisation for
Economic Co-operation and Development
Guidelines for Multinational Enterprises.120
Conversely, Pension Investment Rules in
the regulations under the PBSA limit apension fund to owning no more than 30%
of a company’s director voting shares (the“30% rule”).121 The same or similar rules
apply provincially. It is speculated thatthe 30% rule was originally intended toensure that pension funds remained passive
investors but is now generally considered
incompatible with modern commerce.

Nevertheless, the rule remains in place.
The 30% rule could theoretically make it
difficult for a pension fund to exercise thesame degree of influence over an investee
company as would be the case if thepension fund were not so constrained.
3.2.6

3.2.7

There are several examples of cooperation
among Asset Owners with respect tonon-financial stewardship activities
through industry groups and the settingof good practice standards. For instance,
Investor Leadership Network (“ILN”) has
recently published in Canada a report incollaboration with major institutional
investors such as the Alberta Investment
Management Corp., the Caisse de dépôt
et placements du Québec (“CDPQ”), the
CPPIB, the Ontario Municipal Employees’
Retirement System, the Ontario Teachers’Pension Plan (“OTPP”), and the Ontario
Public Service Employees Union
Pension Trust. The report outlines theirexperiences and recommendations withrespect to the implementation of the goals
set forth by the Task Force on ClimateRelated Disclosures (“TCFD”) (which wasestablished by the Financial Stability
Board in 2015).
The Responsible Investment Association(“RIA”) is an industry association devoted
to the integration of ESG factors into
investment decision-making and theselection and management of investmentsthat provide superior risk-adjusted
returns and positive societal impact.
RIA is composed of Asset Owners,
Investment Managers and Investment
Consultants, including pension funds,
insurance companies, mutual funds, andindividuals. RIA provides educationaland networking opportunities, facilitates
industry collaboration and also conducts

3.2.8

3.3

important research and advocacy work in
the furtherance of this mandate.

ACKNOWLEDGEMENTS

Overall, while the foregoing does not
likely represent the majority of Relevant
Investors in Canada, it demonstrates thatsome of its largest investors are taking anactive interest in IFSI.

EXECUTIVE SUMMARY

Mutual funds

Legal requirements to engage for
Sustainability Impact
3.3.1

3.3.2

For most mutual funds, it is unlikelythat the prudent person standard would
require an IFM/PM to engage in nonfinancial stewardship activities. Nor are
there regulatory obligations that would
require such stewardship.
In the case of IFSI-oriented mutual funds,
though, it is more likely that an IFM/PM ofsuch a fund would, as part of its obligationto act prudently and diligently, have an
obligation to monitor its IFSI investments
on an ongoing basis to ensure that suchinvestments remain consistent with the
purpose of the mutual fund.

Legal freedom to engage for Sustainability Impact
3.3.3

3.3.4

As mentioned, Relevant Investors
are permitted to encourage investee
companies to adopt practices that enhancelong-term financial performance andwould generally be accorded flexibility toencourage positive Sustainability Impacts.
IFMs/PMs would also generally have theflexibility to engage in stewardship activities
with a view to enhancing the financial
performance of investee companies. Thereis also no legal impediment preventing IFMs
from assessing the views of Beneficiaries
with respect to IFSI. Depending on thecircumstances, stewardship activities may
ultimately yield better financial results thansimply selling an investment.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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3.3.5

3.4

We note that stewardship activity by amutual fund is limited by the restriction
against exercising or seeking to exercise
control of an issuer or generally being
actively involved in the management of any
issuer in which it invests.122 Nevertheless,a mutual fund can still actively engage
with an issuer in which it invests throughproxy voting, including voting against
boards that are not operating with a view to
Sustainability Impact.123
Insurance undertakings

Legal requirements to engage for
Sustainability Impact
3.4.1

As mentioned, for insurance companies, it
is unlikely that either the prudent person
standard, or the fiduciary duty owed tothe corporation, would require a Relevant
Investor to engage in non-financial
stewardship activities. Nor are there
regulatory obligations that would require
such stewardship. However, circumstances
could exist in which sustainability risks
are determined to be financially material,in which case consideration of IFSI
approaches would be appropriate.

Legal freedom to engage for Sustainability Impact
3.4.2

3.4.3

237

Insurance companies and their
Investment Managers would generally
have the flexibility to engage in
stewardship activities with a view toenhancing the financial performance ofinvestee companies. Depending on thecircumstances, stewardship activities may
ultimately yield better financial results
than simply selling an investment.
For example, OSFI recently joined theSustainable Insurance Forum (“SIF”)
which is a network of insurance
supervisors and regulators whose goal
is to “strengthen their understandingof and responses to sustainability issues
for the business of insurance.” The SIF
conducts research on emerging risks
and engages in significant knowledge
sharing on supervisory practice and policy
engagement. Additionally, like the ILN,
the SIF, in 2017, issued a joint statement
welcoming the recommendations of the
TCFD. OSFI is also collaborating with the
Bank of Canada on a pilot program toassess financial institutions’ potential risk
exposures related to a transition to a lower
greenhouse gas economy, and OSFI also
contributes to the efforts of the Networkof Central Banks and Supervisors forGreening the Financial System (NGFS) to
identify and assess data gaps as they relate
to financial institution supervision. In
January 2021, OSFI released a Discussion
Paper on climate risks, for industry
review/consultation, particularly by thegeneral insurance (property and casualty
insurance) industry. The Paper noted that
“Some FRFIs [federally-regulated financial
institutions] and FRPPs [federally-regulated
pension plans] may already consider
climate change within the broader context
of environmental sustainability, as anelement of environmental, social andgovernance (ESG) factors. ESG factors
are widely discussed, particularly in theinvestment community, because they canpose financial and reputational risks toinvestees and their asset holders.”124

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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4.

ASSET OWNERS’ ENGAGEMENT IN PUBLIC POLICY WORK TO SECURE SUSTAINABILITY IMPACT

4.1

The following section considers the extent
to which, and on what basis, each type ofAsset Owner is (a) legally required or (b)legally permitted or able to use its position
to engage in public policy work designed
to achieve positive sustainability outcomesand minimise negative sustainability
outcomes, for example, where these are
relevant to the value of portfolio assets.

4.2

4.1.2

4.1.3

238

There is no requirement for any Asset
Owner to engage in public policy work tosecure Sustainability Impact.

Mutual funds

4.2.1

4.3.1

As mentioned, it is unlikely that either theprudent person standard, or the fiduciarystandard, would require a Relevant
Investor to engage in public policy work
to secure Sustainability Impact. Nor are
there regulatory obligations that would
require such public policy work.

4.2.2

4.2.3

Subject to the considerations in 4.1.1 and4.1.2, Relevant Investors are permitted toengage in public policy work. For instance,
the CAAT Pension Plan and OTPP, twolarge Canadian institutional investors are
members of the Canadian Coalition for
Good Governance (“CCGG”).126 The CCGG
engages with the boards of Canadianpublic companies and with Canadian
regulators on governance matters thatare of interest to its members (among
other initiatives, including a voluntarystewardship code).127 It is of note thatOTPP is a member of the Public Policy
Committee of the CCGG.128
In addition, where legislation or policy
creates efficiency in the operations of apension fund and necessitates a change
to minimum standards legislation
or regulatory policy, pension fundadministrators frequently devote timeand resources to pursuing change. Weview this activity as in keeping with theadministrator’s fiduciary duty as it isultimately in the best financial interest ofmembers for inefficiencies to be eliminated.

For the reasons set out in Section 2, we do
not consider that there is any requirement
for a mutual fund to use its position to
engage in public policy work.

Legal freedom to engage for Sustainability Impact
4.3.2

Legal freedom to engage for Sustainability Impact

Relevant Investors may engage in policy
discussions and lobbying to the extent
these activities are consistent with thebest interests of beneficiaries and do notcontravene existing duties. Lobbying
efforts must also be in compliance withapplicable lobbyist registration laws.
Lobbyist registration laws at the federal,provincial and municipal levels generally
require registration before contact withpublic office holders for the purpose oflobbying, subject to limited exceptions.125
While some flexibility is accorded to“in-house lobbyists” – i.e., officers or
employees of an organization who lobby
on behalf of their organization – the rules
vary widely and can make it difficult toengage in policy discussions.

4.3

Legal requirements to engage for
Sustainability Impact

Overarching Considerations
4.1.1

Pension funds

Legal requirements to engage for
Sustainability Impact

4.4

As mentioned in Section 3.2, there isnothing to prevent mutual funds or IFMs/
PMs from lobbying or engaging in policy
discussions, so long as these activities do
not conflict with existing duties, including
any duty to prioritize financial returns.
Insurance undertakings

Legal requirements to engage for
Sustainability Impact
4.4.1

We do not consider that there is any
requirement for a general or life insurer
to use its position to engage in public
policy work.

Legal freedom to engage for Sustainability Impact
4.4.2

As mentioned, however, there is nothing
to prevent insurance funds from lobbyingor engaging in policy discussions, solong as they do not conflict with existing
statutory or regulatory duties of theinsurer. Collaborative public policy
efforts with insurance funds would also
be an option, subject to compliance withapplicable competition law requirements.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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5.

ESTABLISHING NEW FUNDS TO INVEST FOR SUSTAINABILITY IMPACT AND AMENDING THE
TERMS OF EXISTING ONES

5.1

The following section considers the extent
to which it is possible for an Asset Owner
to set up a fund, policy or other productwith the express objective of Investing for
Sustainability Impact.

5.2

Pension funds

Establishing a New Policy
5.2.1

5.2.2

239

It is possible for statutory pension funds
to be established with a requirement toconsider or prioritize IFSI. We note, forexample, that the CDPQ has a mandate
to achieve an optimal return, “while atthe same time contributing to Québec’s
economic development.”129 Community
investment is intended to improvethe economic and social developmentof local communities through job
creation, developing local enterpriseand expertise and providing valuable
service to low income or disadvantaged
groups.130 Although CDPQ’s mandate
does not appear to prioritize IFSI above
achieving optimal return, in practice, its
investment activities include providing
financing as well as business advice to
Québec companies at all stages of theirdevelopment.131 More recently, CDPQ
announced that it is creating a $4 billion
envelope to support Québec companies
temporarily impacted by COVID-19, thefunds of which will be used to address
the specific liquidity needs of companies,
whether or not in CDPQ’s portfolio, thatmeet certain criteria.132
Also, for the reasons articulated above,
we think it is not permissible under thecurrent statutory regime for an employer toestablish an RPP in which IFSI has priority
over, or equal status with, ensuring theplan fund is invested in such a way so as tomaximize the likelihood that the pension
fund will be sufficient to pay promised
benefits within a stated risk tolerance.

Duties on those designing, manufacturing andproviding mutual funds
5.3.2

Duties on those designing, manufacturing andproviding pensions
5.2.3

5.3

As mentioned, there is no legal
requirement for organizations thatprovide pensions to design the planby reference to the needs or views ofBeneficiaries. Under the ITA, the primary
purpose of a pension plan must be toprovide periodic payments to individuals
after retirement and until death in respectof service as employees. Accordingly, it
can be inferred that the primary purposeof a pension fund, and consideration inany design, ought to be to provide fundingthat is sufficient to meet the promised
pension benefit.
Mutual funds

Establishing a New Policy
5.3.1

As mentioned, mutual funds may be
structured to Invest for Sustainability
Impact. Aside from standard investment
restrictions, such as those discussed
at 2.3.9, there are no other legal
restrictions or requirements to set up amutual fund to Invest for Sustainability
Impact. Furthermore, it is permissible
for a mutual fund to prioritize IFSI overfinancial returns, provided that suchmutual fund has IFSI as its fundamental
investment objective.

5.3.3

There is no legal requirement for IFMs
to design a mutual fund by reference tothe needs or views of Beneficiaries. As
discussed above, IFMs and PMs that aremanaging mutual funds marketed as IFSI
have certain obligations with respect toRegulatory Disclosures that may indirectly
engage the views of Beneficiaries. Form
81-101F1, as discussed above at 2.3.16,
imposes annual disclosure requirements,
including its “Fundamental Investment
Objectives”. The regulations further
require the disclosure of the mutual
fund’s investment strategies and theprocess by which IFMs select securities forthe mutual fund’s portfolio.
While such requirements do not persist
throughout the lifetime of the investment,
under NI 81-102, the prior approval ofunitholders is required in order to effecta change in the fundamental investment
objectives of a mutual fund. Therefore,
while not a direct assessment of the viewsof the unitholders with respect to IFSI,
unitholders nonetheless maintain a levelof control over the objective of the mutualfund and whether, if marketed as a fundwith an IFSI objective, it can cease tofollow such an investment objective.133 We
briefly note here that mutual funds canadjust their investment strategies without
the need to amend their fundamental
investment objectives, so long as theadjusted strategy does not conflict.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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Duties on those designing, manufacturing andproviding life insurance

ACKNOWLEDGEMENTS

Establishing a New Policy
5.4.1

5.4.3

EXECUTIVE SUMMARY

5.4

5.4.2

Life insurance products
There is no legal impediment preventing
insurers from assessing the views ofBeneficiaries with respect to IFSI. We notethat amending existing products to havethe express objective of IFSI would likely be
so difficult as to be impractical in Canada
given how insurance funds are structured.
A number of Canadian life insurers alreadyoffer socially responsible investment
products structured as “segregatedfunds”.134 Segregated funds are investment
contracts offered by life insurancecompanies, which, similar to mutualfund products, invest the funds in various
asset classes/types as selected by thepolicyholder. Segregated funds also provide
for guaranteed minimum return levels
upon withdrawal of the invested amount or
upon death of the contractholder. They also
provide certain other benefits, including
increased creditor protection. New socially
responsible investment-oriented segregatedfunds could readily be established/offeredby Canadian life insurers.

The umbrella group of Canadianprovincial insurance market conduct
regulators, the Canadian Council of
Insurance Regulators (“CCIR”), hasrecently published Guidance Respecting
the Conduct of Insurance Business andthe Fair Treatment of Customers (the“Guidance”).135 The Guidance has been
adopted by many of the CCIR member
regulators. The Guidance is designed topromote the fair treatment of customers,
and, among many other expectations,requires that insurers consider the needs
and interests of target consumer groups indesigning, distributing and administering
insurance products. In relation to socially
responsible investments, this could
include the interests and expectations ofinvestors particularly desiring such typesof investments.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

240

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6.

INVESTMENT MANAGERS’ DUTIES TO INVEST FOR SUSTAINABILITY IMPACT

6.1

This section considers the extent towhich, and in what circumstances, an
Investment Manager is (a) legally requiredor (b) legally permitted to Invest for
Sustainability Impact on behalf of an Asset
Owner or otherwise, in each of the three
ways contemplated in sections 2-4.

6.2

In many cases, large institutional
investors opt to retain Investment
Managers to provide expertise and assist
in the management of their investment
portfolios. Asset Owners will typicallyenter into contracts which govern therelationship between the Investment
Manager and the Asset Owner and thereby
create obligations which will bind theInvestment Manager.136 Additionally, anagency relationship will exist where one
party – the agent – is empowered by theother party – the principal – to act onbehalf of and represent the principal, andsuch relationships may arise contractuallyor otherwise.137 An agency relationshiptransfers unto the agent the authorityof the principal to act on its behalf. The
agency relationship creates a number ofduties incumbent upon the agent, which
include:• Duty of Loyalty:

is in a fiduciary relationship withthe principal in the context of theperformance of its undertakings onbehalf of the principal;141• Duty to Avoid Conflicts of Interest:

An agent cannot put themselves insituations in which their personal
interest is in conflict with their duty tothe principal.142• Duty to Make Full Disclosure: Where

the agent enters into a contract with theprincipal, it must make full disclosure of
all material circumstances;143
Profits: The agent cannot make aprofit out of the agency without theknowledge of the principal.144
6.2.1

carry out the instructions of the agent;138• Duty of Personal Performance: Where• Duty to Exercise Care and Skill: An agent

must exercise the care and skill in theperformance of its duties as necessary
for the proper conduct of the businessundertaken, and is liable to the principal
for negligence;140
241

6.3.2

• Duty to Refrain from Making Secret• Duty of Obedience: The agent must obey andthe execution of the agency involves theexercise of judgment and discretion, theagent cannot delegate their authority;139

how it wishes to achieve these will becontemplated in the mandate given
to the Investment Manager, whether
contractually, or simply throughinstructions given in the context of aprincipal-agent relationship. Whether
bound by contract or by the duty ofobedience, though, the Investment
Manager must implement the
Sustainability Impact objectives if this isrequired in the mandate given to them by
the Asset Owner.

• Duty to Act in Good Faith: The agent

6.3

Finally, the Investment Managers retainedby Asset Owners are generally subject
to certain registration requirements
under Canadian securities legislation.145
Specifically, as discussed at 2.3.4, Investment
Managers – whether they are individuals
or firms – will be registered either as
PMs (or Restricted Portfolio Managers) or
IFMs under NI 31-101. Under NI 31-101,
all Investment Managers must satisfy therequirement under the instrument to
conduct themselves with integrity, which
implies honesty and good faith in theperformance of their mandates.146

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa

6.3.3

United Kingdom

Legal obligations with respect to
Sustainability Impact
Practically speaking, it is much more
likely that the Sustainability Impact
objectives of the Asset Owner and

EXECUTIVE SUMMARYEngagement to achieve Sustainability Impact

Powers of investment and divestment
6.3.1

Since there is no legal requirement for
Asset Owners (other than Sustainability
Impact-oriented mutual funds) to pursue
Sustainability Impact objectives, andin some cases it would be prohibited, it
follows there is no legal requirement topursue Sustainability Impact objectives
not incorporated into the investment
management agreement. It is also very
unlikely that the types of Asset Owners
under consideration here (pension funds,
insurance companies, and mutual funds)
would not put in writing the investment
objectives they expect an Investment
Manager to pursue, particularly given thecomplexity of the legal framework underwhich they operate.

ACKNOWLEDGEMENTS

6.3.4

There is no obligation under Canadianlaw that requires Investment Managers
to enquire about the extent to which
Asset Owners have assessed the views ofBeneficiaries. As such, unless there is acontractual obligation to engage, Investment
Managers are generally under no obligation
to engage for Sustainability Impact.

United States

GLOSSARY
REFERENCES

However, there may be circumstances
under which Investment Managers are
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legally required to ensure that Beneficiaries’
IFSI views are taken into account inmanaging a portfolio (if indirectly). For
example, where the Regulatory Disclosures
for mutual funds describe IFSI as a feature,investors will expect that the funds will be
invested in accordance with the Regulatory
Disclosures as such feature is likely to
inform investors’ investment decisions.
While this does not amount to directly
enquiring into the views of Beneficiaries, it
can be argued that the obligation to manage
the fund in accordance with the Regulatory
Disclosures that informed the Beneficiaries’
investment decisions are – in certain
circumstances – to an extent a reflectionof the views of Beneficiaries. Similarly,
the Fundamental Investment Objectives
must state that an objective of the fundis to Invest for Sustainability Impact andamending that objective requires the priorapproval of securityholders/Beneficiaries.
As such, the approval process governingchanges to the Fundamental Investment
Objectives is also arguably a regulatory
process which indirectly solicits input fromthe Beneficiaries.
6.3.5

6.3.6

242

As discussed above, Investment Managers,
as agents, have a fiduciary duty toward
the principal, in this case the Asset Owner.
To fulfil this duty, they may be required tokeep the Asset Owner informed as to theperformance of the investments, which
may include reporting on the extent towhich Sustainability Impact objectives
have been met in managing the portfolio.
Canadian securities regulators have taken
steps to increase disclosure in line with
the SDGs and the Paris Agreement. While
Canadian securities laws do not mandate thepractices of ESG or IFSI, reporting issuersmust disclose all material information,

including any material information withrespect to ESG issues.147 The Canadian
Securities Administrators, an umbrellaorganisation of Canada’s provincial andterritorial securities regulators (“CSA”),
further clarified environmental reporting
obligations in CSA Staff Notice 51-333(Environmental Reporting Guidance), and has
expanded on this guidance with respect toclimate-related risk disclosure in CSA Staff
Notice 51-358 (Reporting of Climate Changerelated Risks). Environmental disclosure,
where it reaches the materiality threshold,will be required with respect, for example,
to environmental risks, trends, anduncertainties, the operational effects ofenvironmental protection requirements,and so on.148 The Toronto Stock Exchange
has issued guidance that while StaffNotice 51-333 does not make explicit
reference to social information, it may beinterpreted to also include material social
information.149 Similarly, as of January 1,
2020, pursuant to an amendment to the
Canada Business Corporations Act (“CBCA”),
specific governance factors must be
disclosed for federally incorporated public
issuers, including diversity practices.150
While privately held businesses are notsubject to such disclosure requirements,
practical and reputational considerations
may in themselves be sufficient to motivate
the adoption of ESG or to invest forsustainability impact.
Public policy work to achieve Sustainability Impact
6.3.7

There is generally no duty on an
Investment Manager to engage in public
policy work unless the contractual
mandate with the Asset Owner includes
some language to the contrary. Any such
efforts would have to be undertaken incompliance with lobbyist registration laws.

6.4

Legal freedom to Invest for Sustainability
ImpactPowers of investment and divestment
6.4.1

6.4.2

Generally, an Investment Manager cannot
choose investments by reference to
Sustainability Impact objectives except
where all financially relevant factors areequal, and in such a case, Sustainability
Impact considerations could be used asa tiebreaker.
However, as previously noted, Investment
Managers are bound by their contractual
duties or their duties as agents, and assuch will generally be bound to set IFSI
objectives where this is required by the
Asset Owner under the contract.

Engagement to achieve Sustainability Impact
6.4.3

There is no express legal impediment
preventing Investing Managers fromengaging in stewardship to achieve
Sustainability Impact. However, they
may be prevented from doing so if theseactions are incompatible with or purport
to take precedence over the objectivesof the contractual arrangement with
the Asset Owner or over the objectives/
purposes of the fund in question under its
constating document.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Public policy work to achieve Sustainability Impact

Netherlands

6.4.4

South Africa

As discussed earlier, there is no express
legal impediment to an Investment
Manager undertaking public policy
work to achieve Sustainability Impact,
provided it complies with lobbying laws
and is not in conflict with the statutory
or contractual duties owed to the Asset
Owner and fund.

United Kingdom
United States

GLOSSARY
REFERENCES

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7.

LEGAL LIABILITY TO THIRD PARTIES FOR THE NEGATIVE SUSTAINABILITY IMPACT OF
ENTERPRISES IN WHICH PORTFOLIOS ARE INVESTED

7.1

This section considers the extent to which,regardless of the legal rules under which itis required to operate and its constitution,
an Asset Owner could be legally liable tothird parties for the negative Sustainability
Impact of enterprises in which it invests,
and whether an Investment Manager could
also be liable because of its role in assisting
the Asset Owner to invest in the relevant
enterprise and steward its investment.

7.2

including regulatory action, damage
to reputation, and litigation risk of theinvestee company. Thus, as part of thefinancial analysis at the time of making an
investment/loan, and on an ongoing basis
as circumstances warrant, an Asset Owner
will want to ensure that it has evaluatedthe level of risk attributable to negative
Sustainability Impacts.
7.2.3

Asset Owners

Primary Liability & Negative Impacts
7.2.1

7.2.2

243

The likelihood of primary liability for an
Asset Owner in connection with a failure
to consider Sustainability Impact or a
failure to engage in stewardship activities
is very low. Indeed, absent a certain levelof control and accompanying conduct, it isdifficult to conceive of the circumstancesin which such a liability might be fixedon an Asset Owner. One example of suchconduct is found in some stewardship
activities that could provide for thefactual underpinning that would enable a
Canadian court to “look through” various
legal forms of investment structures, withthe result that a Relevant Investor who
engaged in stewardship activities could
be held liable for actions of the investee
company. The ability to “pierce the veil” insuch circumstances may act as a deterrent
to stewardship.
It is, however, probably fair to saythat the main liability risk (broadly
construed) of negative Sustainability
Impacts is the possible loss in market
value of an investment resulting frompoor financial performance attributable
to a negative Sustainability Impact,

7.2.4

7.2.6

Nevertheless, legislative amendments
or unambiguous guidance similar tothat in the Manitoba pension legislation
stating that Asset Owners and Investment
Managers who consider IFSI will notthereby be immediately liable for breachof their duty of prudence would be ahelpful step in encouraging investors totake Sustainability Impact into account intheir investment decisions.
We also think it unlikely that a claimant
would be able to establish a duty, letalone a breach of such duty or causative
connection recognized in law so as to fix
liability for negative Sustainability Impacts
on an Asset Owner or Investment Manager
that invests in a company that has caused
negative Sustainability Impacts. Nor do wethink there would be any duty to mitigate
negative Sustainability Impacts.

7.3

Investment Managers

7.3.1

The investment choices made by
Investment Managers will be assessed on
the basis of the process the Investment
Manager engaged in when making theinvestment, and not on the basis of
the financial returns of the portfolio.
Therefore, unless the Investment Manager
was in breach of any of their duties, it isunlikely that they would incur liability.
Practically, though, Investment Managers
will seek to achieve strong financial
performance as Asset Owners are likely toterminate the employment of Investment
Managers who do not meet this standard.

Disclosure Liability
7.2.5

Where a Relevant Investor is required toreport on or disclose the Sustainability
Impacts of its portfolio, this could create
a liability for the Relevant Investor if
the Sustainability Impacts are negative(for example, based on arguments that
the Relevant Investor has helped tofund activities that have a negative
Sustainability Impact).

Such disclosure could create a liability
in the sense of damage to the reputationof the Relevant Investor and/or loss ofmarket value of the investment. In thecase of a mutual fund marketed as an IFSI
fund, it would likely lead to redemptions
and loss of market value. However, it isunlikely that a Relevant Investor would
incur primary liability for such disclosurein the sense normally used in a legal
context – i.e., liability to another personfor provable loss or damage caused by abreach of a legal duty (for example, breachof the prudent person standard) or breachof a contractual covenant. We think thisto be unlikely because the legal nature of
the instruments through which a Relevant
Investor is likely to invest would typicallyinsulate such investor from liability andloss beyond that of the amount invested.151

7.3.2

As noted above, we do not think that Asset
Owners have a duty to either assess theviews of Beneficiaries on IFSI nor to reflect
these views in their investments, and

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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further are under no duty to account for
the impact these investments may have on
beneficiaries. However, should such a duty
exist for Asset Owners, we think it would
be unlikely that Investment Managers
could be found liable to Beneficiaries
in the event an Asset Owner breachedsuch a duty. The relationship between
Asset Owner and Investment Manager
is generally a contractual relationshipin which, commercially, it is typical tofind provisions limiting the liability of
the Investment Manager so as to exclude
actions taken by the Asset Owner. Further,
Investment Managers, as agents bound by
a duty of obedience to follow instructions
given to them by the Asset Owner, cannot
be found liable under the law of agency
for following the instructions given tothem by their principal.152
7.3.3

Moreover, while an agent is in a per sefiduciary relationship with its principal(the Asset Owner), it cannot be said that
there is a per se fiduciary relationshipbetween the Investment Manager and thepersons to whom the Asset Owner owes
a fiduciary duty. Notwithstanding theforegoing, KYC requirements may impose
an obligation on Investment Managers
to have an awareness of statutory
prohibitions and requirements applicableto the Asset Owner.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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8.

THE GROWING IMPORTANCE OF TAKING ACCOUNT OF ESG AND SUSTAINABILITY FACTORSWHERE THESE ARE ‘FINANCIALLY MATERIAL’

8.1

It has become increasingly important for
Asset Owners and their managers to take
ESG and sustainability factors into accountin managing portfolios because of the way
in which they could be material to achieving
the financial investment objectives of
the relevant Asset Owner or manager inaccordance with their legal duties. The main
reasons are summarised below.

8.1.1

8.1.2

245

ESG integration is well established in
Canada, representing $1.9 trillion of
all assets under management.153 ESG isboth a practical and legal consideration
for businesses and investors alike, all ofwhom are increasingly recognizing theimpact of the economy and investing onsociety.154 Support for the considerationof ESG factors exists both in Canadiansecurities law and in the principles ofCanadian fiduciary law.
While neither explicitly mandates theinclusion of ESG factors, disclosure
requirements for public issuers require
disclosure which informs investors
as to the issuers’ environmental andgovernance practices.155 Further practicaland reputational considerations are likely
to motivate private issuers to integrate
ESG factors in their investment decisionmaking processes. Where ESG factors
are known, and are likely to impact theperformance or risk of a given investment,
the common law supports a fiduciary
duty to take these into account.156 In
other words, if negative Sustainability
Impacts are financially material to theperformance of the investment, then Asset
Owners would be required to take accountof them. For example, an increased
regulatory burden for issuers in highcarbon-impact industries would likely
be a financially material consideration.
Moreover, as part of the prudent person
standard and, where applicable, thefiduciary duty, and equivalent duties incivil law, Asset Owners would be required
to evaluate the level of risk posed by suchinvestments, both to the business of theissuer and the reputational risk to theissuer and Asset Owner.
8.1.3

Where such factors are considered bypension funds, at least in the Provinceof Ontario, they must be disclosed in thefund’s SIPP to meet the requirements ofRegulation 909 under the Pension Benefits Act(Ontario).157 Further, the view increasingly
being expressed is that pension fiduciaries
are “expected to consider questions of
future value [and] to assess the impactof their investment decisions on others,
including generations to come.”158
The investment process will require“consideration of market integrity, systemicrisks, governance risks, advisor risks andthe like.”159 This view has been reflected in
the rulings of the Supreme Court of Canada,
which has held that the duty of loyalty– central to the fiduciary relationship –requires the fiduciary to consider boththe pecuniary interests of the beneficiaryand their “status as a responsible memberof society.”160 The implication is thatfiduciaries must avoid practices which areeither unethical or which do not accord
with prevailing social norms in order tofulfill their duties.161 As discussed above,
the CPPIB has implemented its Policy on
Responsible Investing which commits it toconsidering ESG factors in its investment
decisions, and to actively engage withinvestees to spur dialogue with respect to
ESG concerns.162
8.1.4

8.1.5

Dialogue between investors and thebusinesses they opt to invest in is
another means through which investors
may engage in ESG-focused investing.
Shareholder engagement encompasses
practices which leverage shareholder
power to improve corporate ESG
practices.163 While large institutional
investors such as the CPPIB can force
dialogue with their investees, often
directly with management, this may not
be open to all investors.164 However, many
strategies are available under the rules of
the CBCA or any of the provincial BusinessCorporations Acts, such as filing shareholder
resolutions or voting proxies guided byenvironmental and social concerns.165
Screening is another ESG investment
strategy which is adopted in Canada.
Norms-based screening refers to thealignment of investment policies withstated standards, such as the United
Nations Global Compact, while negative
screening involves systematically
excluding investments in specificindustries.166 Some investors may also opt
to invest in businesses which have shown
positive ESG performance, regardless of
their industry (sometimes known as a“best in class” approach).167 Screening as
a form of investment is a practice which
can be more accessible across classes
of investors. An increasing availabilityof mutual funds actively adopting ESG
integration and screening methods
allows both retail investors and major
institutional investors to access more
responsible investments.168

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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9.

THE MEANING OF ‘FINANCIALLY MATERIAL’

9.1

Because of the growing importance oftaking account of ESG and Sustainability
Impact factors into account in theinvestment process where financiallymaterial, it is important to understandhow the law defines what is ‘financiallymaterial’ and the period by reference
to which financial materiality must be
measured. Taking account of these factors
in order to pursue financial objectives may
incidentally have Sustainability Impacts
and may also be consistent with IFSI.
However, beyond that point, any attempt torealise positive Sustainability Impact mightneed to rely solely upon IFSI (i.e. because it
would no longer be driven by the need togenerate financial performance).

9.2

Financial materiality

9.2.1

In Canadian law, financial materiality
is normally treated as a question offact. The provincial Securities Acts define“material fact” in relation to the issuanceor proposed issuance of securities to mean“a fact that would reasonably be expected
to have a significant effect on the market
price or value of the securities.”169

9.2.2

Empirical evidence has established that agood ESG track record contributes to strong
long-term financial performance. The line
between ESG factors and Sustainability
Impact is not well-defined – there isconsiderable overlap – and therefore theevidence of strong long-term financial
performance likely also applies in manycases to positive Sustainability Impacts.
The Sustainability Accounting Standards
Board, an independent standards board,has published a “Materiality Map” which
identifies sustainability issues likely toaffect the performance of companies acrossdifferent industries.170

ACKNOWLEDGEMENTS

9.3

Time period by reference to which‘materiality’ is to be assessed

9.3.1

The time period for financial materiality
varies depending on the Asset Owner
and investment objectives. For example,
the CPPIB, a public sector pension fund,has said that its “exceptionally longhorizon” requires it to consider risk andpotential financial return over “multiple
decades”.171 Similarly, as noted above,
investment portfolios of life insurers
would typically have longer horizons
relative to other insurance products,
given the much longer-term nature oflife insurance companies’ products/
obligations. By contrast, in the mutualfund context materiality tends to beassessed over a much shorter term.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Nicholas Badeen, Stuart S. Carruthers,
Christopher D. Lofft, Stewart Sutcliffe andNatasha vandenHoven, with thanks to Sagar
Darar and Alexandra Ghelerter
246

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1

2

3

4

Morneau Shepell Ltd., Handbook of Canadian Pension and Benefit
Plans (Toronto: LexisNexis Canada, 2016) at 10 [Pension and Benefit
Plan Handbook].
See, for example, Ontario Teachers’ Pension Plan Board,“2019 Climate Change Report” (July 2020), online (pdf):
Ontario Teachers’ Pension Plan https://www.otpp.com/
documents/10179/1021270/2019+Climate+Change+Report/f3eae93f7531-440e-92ea-91275ec52980 [OTPP Climate Change Report].
According to a 2020 survey by the Royal Bank of Canada Global
Asset Management, 89% of Canadian institutional investors surveyed
integrated ESG principles into their investment approach, and
98% believed that ESG-integrated portfolios perform as well or
better than those that do not integrate ESG; RBC Global AssetManagement, “Global Adoption – Regional Divide” (2020), online(pdf) at 4: RBC GAM <https://www.rbcgam.com/en/ca/about-us/
responsible-investment/our-latest-independent-research> [RBC
Responsible Investing Research].
Eric Belli-Bivar & Stephen Viscomi, “The ABCs of ESG” (15 August2019), online: Lexology <https://www.lexology.com/library/detail.
aspx?g=b4f010ed-9ca2-4e58-911f-dbb3609d3040>.

5

Pension and Benefit Plan Handbook, supra note 1 at 10.

6

Pension and Benefit Plan Handbook, supra note 1 at 9.

7

Income Tax Act, RSC 1985, c 1 (5th Supp) [ITA], s 147.1.

8

See ITA s. 149(o).

9Pension plans that provide benefits in excess of the ITA limits for
RPPs are not eligible for the same tax-advantaged treatment.

10

See Income Tax Regulations, CRC c 945, s 8502(a) which states that“the primary purpose of the plan is to provide periodic payments toindividuals after retirement and until death in respect of service as
employees.” As discussed further below, an inference could be drawnthat the primary purpose of a pension fund ought to be to provide
funding sufficient to meet the promised pension benefit.

11

Pension and Benefit Plan Handbook, supra note 1 at 14. Note that
there exist hybrid plans which combine features of DB and DC plans,
as well as plans which are not registered. Neither is discussed here.

12

Benefits Canada, “2018 Top 40 Money Managers Report” (November2018) at 31, online (pdf): Hillsdale Investment Management Inc<https://www.hillsdaleinv.com/uploads/Benefits_Canada_Top_40_
Money_Managers.pdf> [2018 Top 40 Money Managers Report]. See
also Steven Lamb, “Which pension model is best: DB or DC” (June2011), online: Benefits Canada <https://www.benefitscanada.com/
news/which-pension-model-is-best-db-or-dc/>.

13

14

247

See, for example, the OMERS pension plan whereby the OMERS
Administration Corporation acts as administrator of the OMERS
pension plans and trustee of the pension funds per s. 17(1) of theOntario Municipal Employees Retirement System Act, 2006, SO
2006, c 2.
See Pension Benefits Standards Act, 1985 (Canada), RSC 1985, c
32 (2nd Supp) [PBSA], s. 7(1): the administrator of a pension plan
shall be (a) in the case of a multi-employer pension plan establishedunder one or more collective agreements, a board of trustees orother similar body constituted in accordance with the terms of
the plan or the collective agreement to manage the affairs of theplan, (b) in the case of a multi-employer plan not described in (a),a pension committee constituted in accordance with the terms of
the plan to manage the affairs of the plan, and (c) in the case of apension plan other than a multi-employer plan, (i) the employer,or (ii) if the plan is established under one or more collective
agreements and the terms of the plan or the collective agreement(s)to manage the affairs of the plan provide for the constitution of aboard of trustees or similar other body, that body.
15

See Supplemental Pension Plans Act, chapter R-15.1 (Quebec), s
147; The Pension Benefits Act (Manitoba), CCSM, c P32, s 28.1.

16See, for example, Pension Benefits Act (Ontario), RSO 1990, c P8, s.
22(1).

17

Fales v. Canada Permanent Trust Co, [1977] 2 SCR 302 at 315.

18

See for example, Pension Benefits Act (Ontario), RSO 1990, c P8, s.
22(8).

19

R. v. Christophe et al., 2009 ONCJ 586, Langlois c Roy, 2006 QCCS
297, class action settlement approved, 2010 QCCS 1610; Gilbert c.
Syndicat des chauffeurs de la Société de transport de Laval, 2010
QCCS 1540; Syndicat général des professeures et professeurs del’Université de Montréal c. Gourdeau, 2009 QCCS 1990, class action
settlement approved 2015 QCCS 2496, among others.

20

However, see A. Kaplan and M. Frazer, Pension Law, 2nd ed. (Toronto:
Irwin Law, 2013) at 322. The authors speculate that the “standards
imposed upon pension plan administrators are higher than thoserequired of trustee as common law because it is assumed that aperson of ordinary prudence would be more diligent when dealing
with the property of another than they would be in dealing with
their own property”.

21

Fales v. Canada Permanent Trust Co., [1977] 2 SCR 302 at 315-316.

22

See Pension and Benefit Plan Handbook, supra note 1 at 104; while
it is only the pension legislation of Alberta and British Columbia that
expressly identifies pension plan administrators as fiduciaries, thisis how the relationship is viewed in all jurisdictions across Canada(subject to our comments with respect to Quebec), regardless of thetype of pension plan.

32

Pension and Benefit Plan Handbook, supra note 1 at 223.

33

See Schedule III to the Pension Benefits Standards Regulations,1985 (Canada), SOR/87-19 [PBSR] which is incorporated into theregulations of several provincial pension statutes.

34

See s. 7.1 of the PBSR which is incorporated into the regulations ofseveral provincial pension statutes. Certain jurisdictions, for example
Ontario, also require that the SIPP be filed.

35

Office of the Superintendent of Financial Institutions, “Guideline
for the Development of Investment Policies and Procedures forFederally Regulated Pension Plans” (April 2000), online (guideline):
OSFI <https://www.osfi-bsif.gc.ca/Eng/pp-rr/ppa-rra/inv-plc/Pages/
penivst.aspx>.

36

PBSR, supra note 33 s. 7.1(1).

37

See Section 5 which discusses the mandate of the Caisse dedépôt et placement du Québec to invest in “Quebec’s economic
development”.

38

In addition, the Canadian federal government recently proposed
draft legislation to establish national net-zero emissions reduction
targets for the federal government, which could influence the
IFSI approaches of all Asset Owners: Bill C-12, An Act respecting
transparency and accountability in Canada’s efforts to achieve
net-zero greenhouse gas emissions by the year 2050, 2nd Session,
43rd Parliament, Canada, 2020 (introduced 19 November 2020).

39

See Pension Benefits Standards Act (British Columbia), SBC 2012,
c 30, s 60(1) [BC PBSA]. See also Canada Pension Plan Investment
Board Act, SC 1997, c 40, [CPPIB Act] s. 5(c) which states, in relevant
part, that among the objects of the CPPIB is “to invest its assets witha view to achieving a maximum rate of return, without undue risk ofloss”.

40

Pension and Benefit Plan Handbook, supra note 1 at 16.

41

Carol M. Dakai et al, Canadian Employment Benefits and Pension
Guide (Toronto: LexisNexis Canada, 2003) at Commentary S 3418
[Benefits and Pension Guide].

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanada23[1994] 3 SCR 377.

24

Ibid at para 30; see also Burke v Hudson’s Bay Co, 2010 SCC 34 atpara 39.

42

Though it is another issue whether it is an appropriate use ofpension assets to seek such views.

China

25

See for example, Pension Benefits Act (Ontario), RSO 1990, c. P8, s.
22(1). In some provinces, the pension legislation addresses the dutyof prudence more specifically; see Pension Benefits Standards Act(British Columbia), SBC 2012, c 30, s 60(1), which states “pension
plan investments, loans and other pension plan financial decisions
must be made … in the best financial interest of plan members,
former members and other beneficiaries”. See also Employment
Pensions Plans Act (Alberta), SA 2012, c E-8.1, s 62(2), which statesthat investments must be made “in a manner that a reasonable andprudent person would apply to the plan’s portfolio of investments
having regard to the plan’s liabilities.”

43

Benefits and Pensions Guide, supra note 40 at Commentary S 3416.

44

See OTPP Climate Change Report, supra note 2.

European Union

26

The terminology is somewhat confused in Quebec as the term
fiduciaire translates as both “fiduciary” and “trustee” and pension
administrators are often trustees of the pension fund trust.

27

Act respecting Retraite Québec, CQLR, chapter R-26.3.

28

CQLR c CCQ-1991 a 1268-1269.

29

Ibid at 1278.

30

Ibid at 1306 and 1309.

31

PBSA, supra note 14 s 8(4.1).

45

RBC Responsible Investing Research, supra note 3.

46

BC PBSA, supra note 38 s 60(1) and CPPIB Act, s. 5(c).

47Income Tax Regulations, CRC c 945, s 8502(a).

48

Pension and Benefit Plan Handbook, note 1 at 223.

49

The Trustee Act (Manitoba), CCSM, c T160, s 79.1.

50

The Pension Benefits Act (Manitoba), CCSM, c P32, s 28.1(2.2).

51

See 2018 Top 40 Money Managers Report, supra note 12.
Foundations and endowments are responsible for $87,519.4 millionof Canadian assets under management, so while they do notcompete with the largest institutional investors, they remain an
important source of investment in Canada, particularly as relates toinvesting for impact.

52

Government of Canada, “How to draft purposes for charitableregistration”, Guidance CG-019 (25 July 2013), online : Governmentof Canada <https://www.canada.ca/en/revenue-agency/services/charities-giving/charities/policies-guidance/guidance-019-draft-

FranceJapan

Netherlands

South Africa
United Kingdom
United States

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purposes-charitable-registration.html>.
53

54

Government of Canada, “What is the difference between a registeredcharity and a non -profit organizations?” (last modified 23 June2016), online : Government of Canada <https://www.canada.ca/en/
revenue-agency/services/charities-giving/giving-charity-informationdonors/about-registered-charities/what-difference-between-aregistered-charity-a-non-profit-organization.html>.
Canada’s National Advisory Board to the Social Impact Investment
Taskforce, “Mobilizing Private Capital for Public Good: Priorities for
Canada” (September 2014) at 11, online (pdf): MaRS Discovery
District < https://www.marsdd.com/wp-content/uploads/2014/09/
MaRS-National_Advisory_Board_Report_EN.pdf> [Mobilizing Private
Capital 2014].

55

ITA, s. 149.1(1).

56Susan M Manwaring & Natasha Smith, “Canada Weighs in on
Social Impact Investing: Highlights from the Report of the National
Advisory Committee” (September 2014), online: Miller Thomson <https://www.millerthomson.com/en/publications/communiques-andupdates/social-impact-newsletter-formerly-the/september-2014social-impact-newsletter-formerly-the/canada-weighs-in-on-socialimpact-investing/> [Manwaring & Smith].

57

Ibid. See also ITA, ss. 110.1(1)(a), 118.1(1), 149.1(1), 149.1(6.4), 188.1(5)for the definition of “qualified donee”.

58

CRA, Community Economic Development Activities and Charitable
Registration, Guidance CG-014 (9 August 2017) and CRA, Using
an Intermediary to Carry Out a Charity’s Activities within Canada,
Guidance CG-004 (27 November 2020). Such investments fallwithin the CRA administrative policy with respect to program
related investments (PRI).Typically the arrangement is structured
so that the non-qualified donee recipient acts as the intermediaryof the investor charity; direction and control is exercised througha written agreement, monitoring and supervision of the activity,
clear instructions and the intermediary keeping the charity’s funds
separate from its own.

59

60

Fasken Martineau DuMoulin LLP, “Changes to Support Social
Investing by Charities” (23 November 2017), online: <https://www.fasken.com/en/knowledge/2017/11/charitiesandnot-forprofit-20171123> [Changes to Support Social Investing by Charities].
Ibid; See also Bill 154, An Act to Cut Unnecessary Red Tape by
Enacting One New Act and Making Various Amendments andRepeals, 2nd Session, 41st Legislature, Ontario, 2017 (assented to 14
November 2017).

61

Changes to Support Social Investing by Charities, supra note 59..

62

Karim Harji, Joanna Reynolds, Hilary Best, & Mathu Jeyaloganathan,“State of the Nation Impact Investing in Canada” (2014) at 22, online:
MaRS Discovery District < https://ccednet-rcdec.ca/sites/ccednetrcdec.ca/files/impact-investing-canada-2014.pdf> [Impact Investingin Canada].

Bar Review 91, no. 1 (2012): 163-210 at 165 [Waitzer & Sarro].
69

Ibid at 168.

70

Benjamin J. Richardson & Maziar Peihani, “Universal Investors andSocially Responsible Finance: A Critique of a Premature Theory”,
Banking and Finance Law Review 30, no. 3 (2015): 405-455 at 410[Richardson & Peihani].

71

72

Gil Yaron, “Fiduciary Duties, Investment Screening, and EconomicallyTargeted Investing: A Flexible Approach for Changing Times” in Jack
Quarter, Isla Carmichael & Sherida Ryan, eds, Pensions at Work:Socially Responsible Investment of Union-Based Pension Funds(Toronto: University of Toronto Press, 2008) 70 at 72 [Yaron].
John Smith, “Ethical Investment” (Paper delivered at the Pacific
Business & Law Institute Conference, February 21, 2001), online:
Lawson Lundell LLP <https://www.lawsonlundell.com/media/
news/262_EthicalInvestmentPaper.pdf>. In Board of Trustees of
Employee Retirement System of the City of Baltimore v. Mayor
and City Councillors of Baltimore 562 A.2d (Court of Appealsof Maryland, 1989), the court ultimately concluded that where
the cost of making investments in alignment with non, financial,social considerations was de minimis, such investments would not
violate the fiduciary duty, as such investments would best serve
the interests of the beneficiaries over the longer term. In Harries
v. Church Commissioners for England [1993] 2 AII E.R. 300, thecourt determined that an arguably “ethical” investment policy waspermissible. See also Yaron, supra note 71 at 83-85.

73

Yaron, supra note 71 at 91.

74

Randy Bauslaugh & Hendrik Garz, “Pension Fund Investment:
Managing Environmental, Social, and Governance (ESG) Factor
Integration” (1 May 2019) [Bauslaugh & Garz], online: MccCarthy
Tetrault <https://www.mccarthy.ca/en/insights/articles/pension-fundinvestment-managing-environmental-social-and-governance-esgfactor-integration>.

75

Canadian Association of Pension Supervisory Authorities, “Guideline
No. 8 Defined Contribution Pension Plans Guideline” (February2019), online: CAPSA <https://www.capsa-acor.org/CAPSAGuidelines>[Guideline No. 8].

76

An “alternative mutual fund” is a relatively new category of mutualfund that was introduced in 2019 that permits exceptions to certain
investment restrictions that apply to mutual funds set out in NI 81102.

77

A growing proportion of Canadian assets under management in
the retail funds market can be attributed to ownership of securities
of exchange-traded mutual funds (“ETFs”), which are listed on
stock exchanges. ETFs generally follow an index, but some are
more actively managed; Darin Renton, Jonathan Willson andMalcolm Peck-McQueen, “Retail investment funds in Canada:
regulatory overview” (November 2019), online: Practical Law <https://ca.practicallaw.thomsonreuters.com/w-016-0038?transitionType=D
efault&contextData=(sc.Default)&firstPage=true> [Retail Investment
Funds in Canada].

63

Mobilizing Private Capital 2014, supra note 54 at 11.

64

ITA, 149.1(1).

78Retail Investment Funds in Canada supra note 77.

65

Mobilizing Private Capital 2014, supra note 54 at 12.

79

66

Ibid at 12.

67

Cowan v Scargill, [1984] 3 WLR 501 (Ch. Div) at 513.

Canadian Securities Administrators, “Understanding mutual
funds” (2012), online: < https://www.securities-administrators.
ca/uploadedFiles/General/pdfs/mutual_funds_brochure.pdf >[Understanding Mutual Funds].

68

Edward J Waitzer & Douglas Sarro, “The Public Fiduciary: Emerging
Themes in Canadian Fiduciary Law for Pension Trustees”, Canadian80

Retail Investment Funds in Canada, supra note 77

248

81

For purposes of this annex, we will simply use the term “NI” for all
provinces.

82

Retail Investment Funds in Canada, supra note 77.

83

Investment Funds, OSC NI 81-102 [NI 81-102].

84

In Quebec it is the Chambre de la sécurité financière.

85

Understanding Mutual Funds, supra note 79.

86

Retail Investment Funds in Canada, supra note 77.

87

Margaret Grottenthaler & Philip J Henderson, Law of Financial
Derivatives in Canada (Toronto: Carswell, 2019) at 7.3 [Grottenthaler& Henderson].

88

Keith Edward MacMaster, “Responsible Investing: Access Denied”(2019) 34 Banking & Finance L Rev 387 at 391 [MacMaster];
Securities Act (Ontario), RSO 1990, c. S.5, ss. 25(1), 36(1); Securities
Act (Nova Scotia), RSNS 1989, c. 418 ss39A; Securities Act (Alberta),
RSA 2000, C. S-4, s. 75.2.

89

Registration Requirements, Exemptions and Registrant
Obligations, OSC NI 31-103 Part 13. Note that the obligations underPart 13 do not apply the fund managers. See also Retail Investment
Funds in Canada, supra note 76.

90

Ibid.

91

NI 81-102, supra note 83.

92

NI 81-102, supra note 83.

93

Grottenthaler & Henderson, supra note 87 at 10:77.

94

See also MacMaster, supra note 87. Unfortunately, neither the MFDA
nor the IIROC maintain any educational requirements with respect
to investing for impact, and this lack of education further contributes
to the lack of dissemination of impact products.

95

Responsible Investment Canada, “2018 Canadian Impact Investment
Trends Report” (February 2019) at 13, online (pdf): RIA Canada<https://www.riacanada.ca/content/uploads/2019/02/2018-CanadianImpact-Investment-Trends-Report-1.pdf> [Impact Investment
Report]; See also MacMaster, supra note 88 at 393 and 404,
where the author points out that the permitted compensation
structures for mutual fund sales under NI 81-105 are such thatfees are often tied to advisors’ commissions. Impact products, suchas mutual funds investing for impact, are often actively managed
and therefore have higher fees, which in turn impact advisors’commissions, disincentivizing advisors to recommend investments
in such products. ETFs, on the other hand, are less expensive thanmutual funds and can be structured to achieve impact. However,
only IIROC certified investment advisors may advise on alternative
products, such as bonds and ETFs. However, there are ten times
fewer IIROC certified advisors in Canada than mutual fund dealers,and furthermore, IIROC advisors generally have high minimum
thresholds, rendering such investments inaccessible to the majorityof retail investors.

96

Ian Tam, “10 Top Sustainable Mutual Funds in Canada” (April 20,2020), Morningstar, online (article): < https://www.morningstar.ca/ca/
news/201554/10-top-sustainable-mutual-funds-in-canada.aspx>.

97

NI 81-102, supra note 83 at 5.1(1)(c).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States98

NI 81-102, supra note 83 at 2.1(1)(e) and 2.3(1)(a).

GLOSSARY99

Insurance Bureau of Canada, “Insurance Regulators”, (last modified
August 13, 2019), online: IBC <http://www.ibc.ca/on/resources/industry-resources/insurance-regulators> [Insurance Regulators].

REFERENCES

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100

Ibid. Note that generally, insurance regulatory laws are fairly uniform
and based on principles of common law. However, in Quebec, thelaws are structured differently and based on the civil law.

101

SC 1991, c 47.

102

ICA, s 492, 551 and 615(1) and OSFI Guideline B-1 (Prudent Person
Approach); Craig Brown et al, Insurance Law in Canada (Toronto:
Thomson Reuters, 2019) at 2.6 [Brown et al].

103

Ibid (Brown et al.) t 10.4(a).

104

ICA, s 489.1(1).

105

Public Accountability Statements (Banks, Insurance Companies,
Trust and Loan Companies) Regulations, SOR/2002-133, s. 3(1)(c).

106

Note that insurers may only be structured as bodies corporate. An
insurance company in Canada cannot be set up as a trust or otherform of “fund”.

107

ICA, ss 492, 551 and 615(1).

108

For example, in Ontario, under s. 434(1) of the Insurance Act, R.S.O.
1990, c. I.8.

109

BCE Inc v 1976 Debentureholders, 2008 SCC 69 at para 37.

110

Waitzer & Sarro, supra note 68 at 189. See also, Ibid at para 65.

111

In its final report, the Expert Panel on Sustainable Finance,
which was appointed in 2018 by the Government of Canada,
recommended promoting sustainable investment as “businessas usual” within Canada’s asset management community, andobserved that sound environmental stewardship of investments canbe a market competitive advantage: Government of Canada, Expert
Panel on Sustainable Finance, “Mobilizing Finance for Sustainable
Growth” (Final Report, 2019), online: < https://publications.gc.ca/
collections/collection_2019/eccc/En4-350-2-2019-eng.pdf>.

112

Royal Bank of Canada, “Financing Social Good: A Primer on Impact
Investing in Canada” (June 2014) at 12, online (pdf): Royal Bank of
Canada <http://www.rbc.com/community-sustainability/_assetscustom/pdf/Financing-Social-Good.pdf> [Financing Social Good];
See also Responsible Investment Association, “2018 CanadianResponsible Investment Trends Report” (October 2018) at 8, 17,
online: <https://www.riacanada.ca/research/2018-canadian-ri-trendsreport/> [Responsible Investment Report].

113

Ibid at 18.

114

Ibid

115

Chartered Professional Accountants Canada, “An Evolving Corporate
Reporting Landscape: A Briefing on Sustainability Reporting,Integrated Reporting and Environmental, Social and Governance
Reporting” (2015), online: < https://www.cpacanada.ca/en/businessand-accounting-resources/financial-and-non-financial-reporting/sustainability-environmental-and-social-reporting/publications/evolving-corporate-reporting-voluntary-reporting-briefing> at 1.

116

The Conference Board of Canada, “Canada 2030. The Future of
Sustainability Reporting” (August 2018), online: <https://www.
conferenceboard.ca/focus-areas/sustainability>.

117

Bauslaugh & Garz, supra note 74, citing a 2015 study conducted by
Harvard Business School and other sources.

118

Canada Pension Plan Investment Board, “Policy on Sustainable
Investing” (June 2020) at 3, online (pdf): https://cdn2.cppinvestments.
com/wp-content/uploads/2020/10/cpp-investments-policy-onsustainable-investing-june-19-2020-en.pdf>.

249

119

Canada Pension Plan Investment Board, “Proxy Voting Principles
and Guidelines” (February 2020) at 7, online pdf: < https://cdn3.
cppinvestments.com/wp-content/uploads/2020/03/cpp-investmentsproxy-voting-principles-guidelines-2020-ENv2.pdf>.

120

The College of Applied Arts & Technology, “Responsible Investing”,
online: <https://www.caatpension.on.ca/en/investments/responsibleinvesting>.

121

Section 11(1) PBSR, supra note 33.

122

NI 81-102, supra note 83 at 2.2(1)(a) and (b); see also, for example,
the definition of “non-redeemable fund” in s 1 of the Ontario
Securities Act (RSO 1990, c S5), which excludes investing for the“purpose of being actively involved in the management of any issuer
in which it invests” from the defined activities of a mutual fund.

123

For example, BMO Global Asset Management offers a “Sustainable
Portfolio”, which promises to utilize its position as owner of the
ESG mutual funds “to drive positive change through engagement
and proxy voting“; Bank of Montreal, “Responsible Investing”,
online: https://www.bmogam.com/ca-en/institutional/capabilities/
responsible-investing/. Also see TD Canada Trust, “Sustainable
Investing”, online: https://www.td.com/ca/en/asset-management/
resources/sustainable-investing/. Also see filter available at https://www.riacanada.ca/ri-marketplace/investment-options/ for a potential
list of Canadian “responsible investment” mutual funds.

124

OSFI, “Navigating Uncertainty in Climate Change” (discussion paper)(11 January 2021) at p. 7, online (pdf): <https://www.osfi-bsif.gc.ca/
Eng/Docs/clmt-rsk.pdf>.

125

See for example: Lobbying Act (Canada), RSC 1985, c 44 (4th Supp);
Lobbyists Registration Act, 1998 (Ontario), SO 1998, c 27, Sch.;
Toronto Municipal Code, chapter 140 (Lobbying).

126

The College of Applied Arts & Technology, “Responsible Investing”,
online: <https://www.caatpension.on.ca/en/investments/responsibleinvesting>.

127

Canadian Coalition for Good Governance, “Policies”, online: <https://
ccgg.ca/>.

128

Ontario Teachers’ Pension Plan, “Influence”, online: <https://www.
otpp.com/investments/responsible-investing/influence>.

129

An Act Respecting The Caisse de dépôt et placement du Québec,2004, c 33, s 4.1.

130

Pension and Benefit Plan Handbook, supra note 1 at 215.

131

Caisse de dépôt et placement du Québec, Contribution to Québec’s
Economic Development (April 2012), online: <https://cdpq.com/
sites/default/files/medias/en/nouvelles-medias/documents/ra2012_
contribution_quebec_economic_development_en.pdf>.

132

Caisse de dépôt et placement du Québec, ”CDPQ joins the collective
effort during the COVID‑19 Crisis” (March 30, 2020), online (press
release): <https://www.cdpq.com/en/news/pressreleases/cdpq-joinsthe-collective-effort-during-the-covid-19-crisis>.

133

NI 81-102, supra note 83 at 5.1 (c). Unless a greater majority
is required by the constating documents of the fund, the laws
applicable to the fund, or an applicable agreement, the approval of
the unitholders shall be given by a resolution passed by at least amajority of the votes cast at a meeting of the unitholders.

134

For example, RIA Canada lists the London Life Ethics Fund, theCanadian Co-Operative Investment Fund, Desjardin’s DFS GIF –Conservative Fund, IA Clarington’s Inhance Monthly SRI Fund, and

the GWL Socially Responsible Bond, amongst a number of other
segregated funds offered in Canada. For more, see: RIA Marketplace,“Investment Products” (2020), online: <https://www.riacanada.ca/
ri-marketplace/investment-options/>.
135

Insurance Regulators, supra note 99.

136

Canadian Encyclopedic Digest, 4th ed (Toronto: Thomson Reuters
Canada Ltd (Westlaw online), June 2020), [CED Agency] at § 1-2.

137

Ibid at § 15-16.

138

Ibid at § 124.

139

Ibid at § 135.

140

Ibid at § 143.

141

Ibid at § 150.

142

Ibid at § 157.

143

Ibid at § 167.

144

Ibid at § 174.

145

See for example Securities Act, RSO 1990, c S5, s.25; Securities
Act, RBSC 1996, c 418, s. 34; Securities Act, RSA 2000, c S4, s. 75;
Securities Act, 2001, RSQ, c V-1, s. 148.

146

Ontario Securities Commission, “Initial Requirements”, (last modified2020), online: OSC <https://www.osc.gov.on.ca/en/Dealers_initialrequirements_index.htm#firm-requirements>. See also Portfolio
Management Association of Canada, “Canadian Securities
Administrators Consultation Paper 33-404 – Proposals To Enhance
the Obligations of Advisors, Dealers and Representatives Toward
Their Clients”, (last modified September 277, 2016), online: PMCA <https://pmac.org/wp-content/uploads/2016/09/PMAC-submission-onCSA-33-404-final-Sept-27.pdf> whereby, additionally, certain industry
standards such as the CFA Institute’s Code of Ethics and Standardsof Professional Conduct binds the members of the CFA Institute to afiduciary duty towards their clients.

147

Chartered Professional Accountants Canada, “Environmental, Socialand Governance (ESG) Issues in Institutional Investor Decision
Making” (July 2010) at 16-19, online (pdf): CPA Canada < https://www.cpacanada.ca/en/business-and-accounting-resources/financialand-non-financial-reporting/mdanda-and-other-financial-reporting/publications/institutional-investors-environmental-social-governanceissues>.

148

Toronto Stock Exchange, “A Primer for Environmental & Social
Disclosure” (March 2014) at 11-12, online (pdf): TSX < https://www.tsx.
com/resource/en/73> [Primer for Environmental & Social Disclosure].

149

Ibid.

150

An Act to amend the Canada Business Corporations Act, theCanada Cooperatives Act, the Canada Not-for-profit Corporations
Act and the Competition Act, SC 2018, c. 8, s. 24.

151

We also assume that the factual bases upon which it is theoreticallypossible to “pierce the veil” are not present.

152

See Pension and Benefits Act, RSO 1990, c P8, s 22(8). An exception
may exist wherein Investment Managers in Ontario would be boundby the same duty to exercise the care, diligence and skill in theadministration and investment of the fund as a person of prudence
as the administrator of the fund. This provision is unique to Ontario.

153

Sustainable Insurance Forum, online: <https://www.
sustainableinsuranceforum.org/>.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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CONTENTSFOREWORDSINTRODUCTION
Eric Belli-Bivar & Stephen Viscomi, “The ABCs of ESG” (15 August2019), online: Lexology < https://www.lexology.com/library/detail.
aspx?g=b4f010ed-9ca2-4e58-911f-dbb3609d3040>.

ACKNOWLEDGEMENTS

155

Ibid.

156

Bauslaugh & Garz, supra note 74.

EXECUTIVE SUMMARY

157

RRO 1990, Reg. 909, s 78(3) provides that the pension fund’s
SIPP “shall include information as to whether environmental,social and governance factors are incorporated into the plan’sinvestment policies and procedures and, if so, how those factors areincorporated”; see also Financial Services Commission of Ontario,
Environmental and Social Governance (ESG) Factors, Investment
Guidance Note IGN-004 (January 2016) at 1.

154

158

Waitzer & Sarro, supra note 68 at 168.

159

Ibid at 168.

160

Ibid at 183-184.

161

Ibid at 184, 189.

162

Ibid at 191.

163

MacMaster, supra note 88 at 7.

164

Ibid at 9.

165

Ibid at 8, 17.

166

Ibid at 7.

167

Ibid at 8.

168

Ibid at 10, 29.

169

See for example, Securities Act (Ontario), RSO 1990, c S5, s. 1(1).

170

Sustainability Accounting Standards Board, “SASB Materiality Map”,
online: <https://materiality.sasb.org/>.

171

CPPIB, 2019 Report on Sustainable Investing: Investing Responsibly
for CPP Contributors and Beneficiaries (undated) at p. 3, online:<http://www.cppib.com/documents/2129/CPPIB-2019-Report-onSustainable-Investing-Board-EN_6MB_version.pdf>.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

250

Freshfields Bruckhaus Deringer LLPCONTENTS

A LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCHINAFOREWORDSINTRODUCTION

1.

INTRODUCTION

1.1

This annex considers the laws of thePeople’s Republic of China (China or
the PRC, for the purpose of this annex
only, excluding Hong Kong, Macau andTaiwan) as at 31 January 2021. Sections 2
to 4 address the ability of Asset Owners
to Invest for Sustainability Impact where
the relevant portfolio does not have an
express sustainability impact objective.1

1.2

As discussed in the main body of thereport, the expression “investing forsustainability impact” (IFSI) is not a term ofart. Rather, the expression is used here asa “conceptual net” to denote any power orfreedom on the part of an Asset Owneror its Investment Manager to pursue one
or more sustainability impact objectives,
whether to protect or enhance thefinancial performance of their investment(instrumental IFSI) or otherwise(ultimate-ends IFSI).

ACKNOWLEDGEMENTS

pension funds or insurance undertakings)
are all contract-based arrangements.
General rules and principles
1.5

1.6

Underlying legal relationship
1.3

1.4

251

China is a civil law jurisdiction and has
developed various legal concepts of its own.
In the asset management industry, one of
the fundamental issues is the inconclusive
dispute on the nature of the underlying
legal nature of various fund schemes, andaccordingly, the rights and obligations of
Relevant Investors. There are two mainviews in practice: the fund scheme is either(a) a trust or (b) a so-called “entrustment”
contractual arrangement.2
Unless explicitly stipulated as trusts,
fund schemes are commonly regarded
as contract-based entrustment
arrangements. For the purpose of thisannex, this issue is relevant only tomutual funds that are public funds.
Other funds considered in this annex (eg2015, the politburo of the CCP passed theOverall Plan for Ecological Civilization
System Reform, which establishes theconcept of “mountains, rivers, forests,
farmlands, lakes and grasslands” as acommunity of life.6 The following month,
the further establishment of the ecologicalcivilization was written into the five-yearplan of the country for the first time and,in March 2018, was written into China’s
constitution. On 15 March 2021, President
Xi stated during the ninth meeting of
the Central Committee for Financial andEconomic Affairs that achieving net-zerocarbon emissions should be incorporated
into the ecological civilization plan.
5

Under PRC law, general legal duties (eghonesty, good faith, prudence and diligence)or principles (eg the national/public interest,
safety, profitability and long-termism) thatare applicable to Relevant Investors for
asset management and investment may
literally or logically be construed to include
IFSI considerations. However, in the absenceof express statutory or judicial standards,3such general duties and obligations areusually too abstract to be regarded as abasis for requiring Relevant Investors to
IFSI or for permitting IFSI. Instead, general
duties and obligations are more likely to bereferred to when a specific provision under
PRC law is ambiguous.
As a result, a legal uncertainty persists
under PRC law on whether Relevant
Investors have general legal duties or thediscretion to IFSI in the absence of express
statutory or contractual requirements,
and if so, to what extent such a duty could
be deemed as being discharged.

China’s concept of ecological civilization
1.7

1.8

“Ecological civilization” means a newstage in the development of humancivilization after the current industrial
civilization, a sum of material andspiritual results to be achieved by
mankind following the rule of theharmonious development of man, natureand society.4
In November 2012, the 18th national
congress of the Chinese Communist
Party (CCP) for the first time decided to“vigorously promote the establishment ofan ecological civilization”. In September

1.9

In the area of investment and financing
with respect to ecological civilization,
the Guidelines for Establishing the Green
Financing System (the Green Financing System
Guidelines) and the Guidelines for Promoting
the Investment and Financing in Response
to Climate Change (the Climate Investment
and Financing Guidelines) were published inAugust 2016 and October 2020 respectively
by the central environmental authority andmultiple financial regulators7 encouraging
private investment into areas related toenvironmental sustainability. There arealso a number of official guidelines as “softlaw” standards, encouraging private capitalto engage in other sustainability impactrelated areas, including, for example, theproposal issued by IAMAC for investment
by insurance funds,8 the investment
principles for Belt and Road initiatives,9and investment guidelines proposed by
AMA10. However, none of these standards
have yet amounted to any express legal
grounds for Relevant Investors to be
obliged or free to IFSI.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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CONTENTSFOREWORDSINTRODUCTION

2.

ASSET OWNERS’ USE OF POWERS OF INVESTMENT AND DIVESTMENT TO INVEST FORSUSTAINABILITY IMPACT

2.1

The following section considers the extent
to which, and in what circumstances, eachtype of Asset Owner is by law required,or permitted or able, to use its powers ofinvestment and divestment to Invest for
Sustainability Impact.

2.2

2.2.3

Pension funds

Types of pension fund covered
Public schemes
2.2.1

2.2.2

252

We consider in this section the Basic
Pension Fund (BPF), the largest sovereignpension scheme in China, and the
National Social Security Fund (NSSF), anational reserve fund supplements thesocial security expenditures of a rapidly
aging population.
The BPF is a dual-track pension system,
under which: (a) an employee shallcontribute 8% while the employer shallpay 20% of the employee’s total salaryto the system; and (b) an unemployed
or a self-employed person shall pay a
fixed amount as determined by the local
government from time to time. The
portion of funds contributed by individual
employees and part of the funds paidby those who are unemployed or selfemployed will be put in their personalaccounts, out of which the benefits arepaid on a defined-contribution (DC) basis,
while the portion paid by the employers
and the rest of the funds paid by those
who are unemployed or self-employed
will be pooled in an account at provincial
level, out of which the benefits are paid ona defined-benefit (DB) basis. The benefits
are guaranteed by statute. With the
population continuing to shift from rural
to urban areas, the pressure on the BPF is

2.2.4

increasing, as people who used to live inrural areas may be entitled to an increased
benefits after they move to an urban area,
and the funds in the pooling accounts at
provincial level cannot be transferred.

raise funds from individual pensioners,
functions as a supplemental funding
source for social security expendituresand has other functions beyond paying
individual pensioners,

The fund assets of the NSSF are raised
through state financial appropriation,state-owned capital re-allocation,
investment income and other methods asapproved by the State Council.

• Investment decision-makers: the trustees,

The key entities are:or the Investment Manager(s) appointed
by the trustees.
Private schemes
2.2.5• Asset Owners: the administering

authorities, as sponsors of the BPF and
the NSSF, are responsible for fundraising,account management and distributionof benefits by law, and are required toappoint qualified third-party trustees(trustees) to manage and operate thefund assets. Although the trustees holdno legal title to the fund assets, they
will be deemed the Asset Owners forthe purpose of this annex, as they can
exercise substantially all investment
powers related to the fund assets. For
NSSF, the trustee must be the National
Council for Social Security Fund (NCSSF),
an organization specially established forthis purpose, as required by the relevant
regulations.11

2.2.6• Beneficiaries: for the BPF, the unspecified

pensioners are entitled to receive all thebenefits under the applicable laws andregulations.12 It is not clear if this covers
only existing pensioners or those whowill become pensioners in the future as
well. We consider the NSSF as having
no specific beneficiaries but instead
acts for the benefit of the overall social
security system. This is because it does not

2.2.7

We consider in this section occupational
pension funds, which are composed of:(a) the Occupational Annuity Fund (OAF),
which is mandatory for all government andpublic institution employees; and (b) theEnterprise Annuity Fund (EAF), which is
optional for enterprise employees. We haveexcluded contract-based pension schemes
operated by insurers (addressed below at
Section 2.4) from our consideration.
Under the OAF, an employee contributes
4% while the employer pays 8% of theemployee’s total salary. Under the EAF,
where adopted, an employee shall be
auto-enrolled unless they opt out, andcontribute up to 8%, and the employee
and their employer shall collectively pay
up to 12% of the employee’s total salary.
Unlike the BPF, which is a mixture of
DC and DB plans, funds paid by both
employers and employees into the OAF
and the EAF are put in the employees’
personal accounts and paid on either a DB
or DC basis.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY

The key entities are:
• Asset Owners: as fund sponsors, both

REFERENCES

employers and employees are responsible
for establishing the fund plan, fundraisingand managing accounts by themselves
Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCHINA

CONTENTSFOREWORDSINTRODUCTION

or via a third party, and are required toappoint trustees to manage and operate
the fund assets. As for public schemes, thetrustees will be deemed the Asset Owners
for the purpose of this annex.
• Beneficiaries: pensioners whose

enrolment is conditional on their having
the necessary continuous service.
• Investment decision-makers: the trustees,or the Investment Manager(s) appointed
by the trustees.
Overview of investment duties and powers

the management or within thesame fund,17 no embezzlement or
misappropriation of fund assets,
no self-profiting and no guaranteed
return or principal;(b) the terms of the entrustment agreementwith the fund sponsors similar to the
obligations under laws and regulations,albeit with certain supplements;(c) contractual18 and agency19 duties owed by
the trustees to the fund sponsors arising outof the entrustment arrangements, including:(i)

Public schemes
2.2.8

Typically, the trustees’ investment duties
and powers are shaped by:(a) special laws and regulations13 regarding
the administration of the pension funds,
which notably specify or require:(i)the BPF and the NSSF to achieve “thevalue preservation and appreciationof fund assets while preserving the
integrity and liquidity of the fundassets”14 without a definitive duration.
For the NSSF, the relevant regulations
also emphasize consideration of thesafety, profitability and long-termismof the investments;15(ii) the establishment of investment
strategies and risk control policies;(iii) investing in accordance with the fundobjective and investment strategies
referred to above;(iv) compliance with portfolio
diversification requirements;16(v)

conducting business with honesty,
good faith, prudence and diligence;(vi) no commingling of fund assets,no unfair treatment of fund assets
with assets of other funds under253

the duty of care as a bona fide
manager, or in other words, the dutyof prudence and diligence; and(ii) no delegation and no self-trading (ineach case, unless so permitted by theentrusting party).
2.2.9

The standard of the trustees’ duties
of honesty, good faith, prudence anddiligence to the fund sponsors arisingout of special laws or the contract-based
entrustment arrangements has not been
explicitly established under PRC laws.
In practice, it is usually understood tobe similar to that of the fiduciary duties
of loyalty and care of the directors andsenior management of a Chinese company(Section 2.2.10) with certain deviations
where justified. However, no exact scopefor such permitted deviations has been
established in practice in respect ofachieving a (particular) financial returnor IFSI.

2.2.10 The standard for directors’ and senior
management’s fiduciary duty in a PRC
company as commonly accepted inpractice is set out below:20(a) The duty of honesty and good faith
mainly require:(i)no misappropriation of company assets;(ii) no deposit of company assets into
personal accounts;

ACKNOWLEDGEMENTS(iii) no provision of loans or guarantees toothers with company assets;

EXECUTIVE SUMMARY(iv) no self-trading;(v)

no usurpation of the company’sbusiness opportunities or the
carrying on of any businesscompeting with the company;(vi) no commission or fees to be received
from a third party for transactions
between the company and the third
party; andA. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM(vii) no disclosure of the company’s secrets.
However, items (iii) to (v) above canbe exempted if permitted in theconstitutional documents or be
authorised by the approval of theshareholders’ or board meeting.
(b) The duty of care as a bona fide manager
or the duty of prudence and diligencerequires the exercise of the professional
knowledge, skill and experienceof a prudent person under similar
circumstances.21
We have not seen or found any guideline,
past case or discussion on the applicationof these duties in the context of IFSI.
Private schemes
2.2.11 The objective as well as the duration
and any termination events of the EAF
will be determined on a case-by-casebasis as provided in the fund plan. Fund
documents of the EAF should strictly
follow the format and content guidelines
issued by the human resources andsocial security department and be filedwith the same as a record. According
to a template plan provided by theregulatory authorities,22 the objective of

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the EAF is to achieve “appropriate profits
while preserving the integrity of thefund assets.” As the relevant laws andregulations of the OAF are silent on thefund objective, we expect that it will be
provided in the fund plans, and that thefund documents will have similar terms asthat of the EAF given the governmental orsemi-governmental nature of the sponsorsof the OAF.23
2.2.12 The trustees’ investment duties and powers
are similar to that of public schemes(Sections 2.2.8(a)(ii) to 2.2.8(c)), being
shaped by special laws and regulations
regarding the administration of pension
funds24 as well as the terms of theentrustment agreement. In addition, thefund sponsors will separately adopt afund plan, setting forth the fund objective(Section 2.2.11) and other matters in detail.
Legal requirements to use investment powers to IFSI
2.2.13 We do not generally consider that thetrustees are subject to an express duty to
IFSI (either instrumental or ultimate-ends
IFSI) due to the lack of specific provisions
implementing the high-level principles
referred to in Sections 1.5 and 1.7-1.9.
2.2.14 However, the beneficiaries of the BPF are
the unspecified pensioners (current or
future) as a whole, while the NCSSF is
required to manage the fund with the goalof long-termism. In each case, the dutiesof the trustees (ie the duties of honesty
and good faith, or more specifically, fairtreatment of all fund assets), together
with the objectives of the BPF and the
NSSF to achieve “value preservation
and appreciation of fund assets while
preserving the safety and liquidity of
the fund assets” and the objective of
the EAF to achieve “appropriate profits
while preserving the integrity of the fund254

assets,” could be construed as requiring
the trustees to secure the interests of thefunds for not only current but also future
pensioners and to serve the interests ofall beneficiaries fairly, not prejudicing
the interests of persons to whom benefits
will be paid in the future to serve thosecurrently receiving benefits due to thelong-term negative sustainability impact
at a systemic level. As such, it might besuggested that the trustees have a duty
under PRC law to pursue instrumental
IFSI if by so doing they could mitigate thatnegative sustainability impact. However,
we do not see any specific precedent or
indication in applicable law or regulation
for this view, nor is there any specificrequirement for the trustees to collaborate
with other investors to do so.

ultimate-ends IFSI that is prioritized overor has a negative impact on the financial
performance). For example:(a) it is not clear to what extent the financial
return may be compromised as a resultof consideration of sustainability impact
in the eyes of the court when assessing if
the trustees have discharged their existing
duties, and the court may hold the viewthat the outcome should be at least
comparable to that of similar portfolios
managed by a prudent third-party
professional and not significantly lessthan could have been achieved without
IFSI; and(b) where the benefits of the BPF areguaranteed by national finances andfurther supplemented by the NSSF, or
DB or mixed plans are adopted, the fundsponsors may in practice exert pressure
over the trustees to pursue a short- or
medium-term financial return, as theywould be responsible for making a further
contribution to the pension funds if thefunds were to underperform over the
short or medium term.

Legal freedom to use investment powers to IFSI
2.2.15 We do not consider that there is anover-arching duty under PRC law for
the trustees to pursue a particularfinancial return, which would exclude
any possibility of managing the fund toachieve other non-financial goals. Neither
the “value preservation and appreciation”
for public schemes nor the “appropriate
profitability” for private funds shouldnecessarily be construed as requiring
the trustees to maximize or achieve aparticular financial return without explicit
statutory requirements, although literally
these terms seem to be more concernedwith financial performance. In the absenceof any specific requirement, we therefore
consider that the applicable legal rules
offer some flexibility for a trustee to IFSI
(including ultimate-ends IFSI).
2.2.16 However, there are issues that may makethe trustees cautious about utilizing theflexibility available to IFSI (particularly theOn the other hand, the trustees may faceless pressure in adopting instrumental
IFSI since instrumental IFSI, by definition,is less likely to compromise the fund’s
financial return.
2.3

Mutual funds

Types of mutual fund covered
2.3.1

We consider in this annex publicly offeredsecurities investment funds (public funds),
a category of large-scale mutual funds
offered and managed by licensed publicfund management companies (publicfund managers). Public funds are subject
to stringent regulation and supervision in
China, and are the most common form of

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regulated mutual funds. We have excluded
asset management schemes offered byother financial institutions, who arelicensed to establish and operate theirrespective asset management schemes
under the segregated operation regime, or
privately offered by public fund managers.
2.3.2

2.3.3

2.3.4

255

Public funds can be structured as either
contract-based entrustment arrangements
or unit trusts according to the provisionsof relevant laws and regulations, and thefund agreement between unitholders andpublic fund managers. The vast majorityof public funds are open-ended funds,
according to statistics disclosed by AMAC25(as defined below). The agreements
between fund managers and unitholders
provide when and how unitholders
can subscribe and redeem their units,
so public funds are required to holdsufficient cash or government bonds forredemption purposes.26
Closed-ended public funds must last for
10 to 15 years, while open-ended publicfunds can continue for an indefinite
term unless terminated pursuant to thefund documents. The prospectus, whichcontains the key information in relation to
public funds (including the fund objective,
investment policies, etc.), together withthe fund agreement and other funddocuments, must be registered withthe regulatory authorities and disclosed
to potential investors before a public
offering. In case of any material changes27
thereto, the public funds managers
must re-register the fund documentswith the regulatory authorities before
implementing the changes.
For both trusts and contractual
entrustments, unitholders subscribe tofund units by paying the subscription

price to public fund managers. The fundassets are registered in the name of the
managers (rather than the public funds)
but are independent from their own assets
and shielded from being seized on thebankruptcy of the public fund managers.
During the term of a public fund, theunitholders may, through the unitholders’general meeting, unilaterally amend the“key terms” of the fund agreement anddetermine other matters relating to thefund,28 but not directly participate in orinterfere with the investment activitiesof public funds.29 Procedural rules for theunitholders’ general meeting are provided
in the fund agreement.
2.3.5

The key entities are:
• Asset Owners: public fund managers.
• Beneficiaries: for closed-ended funds,

current unitholders, and for open-ended
funds, the unitholders. The law andpractice are silent on whether future
unitholders are also Beneficiaries of openended funds.
• Investment decision-makers: publicfund managers. Public fund managers
are not licensed to appoint Investment
Managers to manage portfolio investments;
rather, according to the internal control
requirements,30 they shall establish,
improve and strictly comply with theirinternal Investment decision-making policy
and prevent ultra vires decision-making.
Overview of investment duties and powers
2.3.6

A fund scheme for asset management in
China by its nature31 is more like a trust,and the parties thereto are required tocomply with the duties and obligations
under the trust law.32 However, as
China has long adopted the principle ofsegregated operation to regulate financial

institutions, under which each type offinancial institution may carry out only
one kind of financial business, it may giverise to regulatory risk when a financial
institution that is not a registered trust
company claims that the schemes it
manages are trusts. The Supreme People’s
Court of China has also clarified that
not all fund schemes (eg public funds
schemes) shall constitute a trust scheme
under the trust law.33
2.3.7

Typically, the public fund managers’
investment duties are shaped by:34(a) special laws and regulations35 regarding
the administration and operation of the
public funds, which notably specify:(i)duties similar to that of pension
funds (Section 2.2.8(a)(ii) to (vi)); and(ii) no damage of the national/
public interest;(b) the terms of the fund agreement similar
to obligations under the laws andregulations, albeit with supplementary
information:(i)fund name, objective andinvestment policies;(ii)

fund structure (eg trust/entrustment
arrangement) and operational
mechanism (eg open- or closed-ended);(iii) portfolio diversification requirements
and investment restrictions; and(iv) rules for procedures and other mattersat unitholders’ general meetings;(c) contract law and agency duties owed to theunitholders arising out of the entrustment
arrangements (Section 2.2.8(c));(d) trust law36 duties owed to beneficiaries
arising out of trusts, which are
independent from the entrustment
arrangement (Section 1.3), including:

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CONTENTSFOREWORDSINTRODUCTION(i)the duty to handle trust affairs in thebest interests of the beneficiaries withhonesty, good faith, prudence andeffectiveness (Section 2.3.8); and(ii) no self-dealing (unless permitted by
the trust documents and at a fairmarket price), no self-profiting (otherthan payment required by law) andno possession of trust assets (unlesspermitted by the trust documents or
principals, and at a fair market price).
2.3.8

2.3.9

256

The standard for the principle of being in
the best interests of beneficiaries undertrust schemes, as a general principle ofthe fiduciary duty of loyalty,37 has notbeen explicitly established under PRC
law. Literally speaking, it requires a
substantial inquiry into the merits of thetrustees’ acts, provided that self-profiting,possession of trust assets and self-dealing
are presumed invalid. We have seencases where the courts have held thetrustees liable for breaching the principleof best interests when the trust assets
were adversely affected, but there is noconclusive meaning of “best interests” inpractice in respect of the duty to achieve a(particular) financial return or IFSI.
The standard of public fund managers’
duties of honesty, good faith, prudence
and diligence/effectiveness38 to theunitholders arising out of special laws
or the contract-based entrustment
arrangements or trusts has not been
explicitly established under PRC laws.
In practice, it is usually understood tobe similar to that of the fiduciary duties
of loyalty and care of the directors andsenior management of a Chinese company(Section 2.2.10) with certain deviations
where justified. However, the exact scopeof such permitted deviations has not been

established in practice in respect of the
duty to achieve a (particular) financial
return or IFSI.
Legal requirements to use investment powers to IFSI
2.3.10 We do not generally consider that the
public fund managers are subject to an
express duty to IFSI (either instrumental
or ultimate-ends IFSI) for the similarreasons mentioned in Section 2.2.13.
2.3.11 However, as for pension funds (seeabove Section 2.2.14), for open-ended
public funds, the systemic risk ofjeopardizing the interests of potential
future beneficiaries for the interests ofthe current ones may practically require
public fund managers to consider longterm negative sustainability impact or
instrumental IFSI. As such, the publicfund managers arguably also have a duty
under PRC law to pursue instrumental
IFSI, although we do not see any specificprecedent or indication in applicable law
or regulation for this view, nor is there
any specific requirement for the publicfund managers to collaborate with otherinvestors to do so.
Legal freedom to use investment powers to IFSI
2.3.12 We consider that the applicable legal rules
offer some flexibility for a public fundmanager to IFSI (including ultimate-ends
IFSI). However, there are issues that may
make public fund managers cautious
about utilizing the flexibility available to
IFSI (particularly the ultimate-ends IFSI
that is prioritized over or has a negative
impact on the financial performance). For
example:(a) Due to the lack of a standard for theunitholders’ “best interest,” it is not clear
to what extent IFSI considerations may
have compromised financial returns in

the eyes of the court when assessing if the
public fund managers have discharged
their duties.
(b) Financial return is focused on thebenchmarks commonly used in rating
public fund performance. This may inpractice exert pressure on public fundmanagers not to IFSI if it has a negative
impact on financial return. For example,
the valuation indicators adopted by therating system of the Golden Bull Award,
also known as The Oscars of China’s
investment fund industry, focus on (i) asingle fund’s financial return over the
short to medium term (eg three or five
years),39 and (ii) the overall portfolio
performance of stock and fixed income
assets and the AuM of a public fundmanager. In contrast, barely any nonfinancial indicators as indicated in thegoal of the award40 are considered.
(c) The public funds’ stated investment
objectives and strategies, which areestablished prior to the units being madeavailable to the public, determine thefactors public funds managers may take
into account when making investment
decisions. The objectives and policy
must be disclosed in the documentation
constituting the scheme, which mustbe true, accurate and complete.41 If
sustainability impact carries substantial
weight in investment decision-making,the public fund managers may need todisclose it as part of the objective or policy,
and this may make such fund schemes lessattractive to profit-driven investors.
On the other hand, the public fundmanagers may face less pressure in
adopting instrumental IFSI since
instrumental IFSI, by definition, willserve the financial return objective.

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B. THE EXTENT TO WHICH
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A LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGCHINAFOREWORDSINTRODUCTION

Insurance undertakings

2.4

insurer’s liability is to pay out when a valid
claim is made by the relevant policyholder.
Any profits of investment activity areretained by the insurer.

Types of insurance undertaking covered
2.4.1

The scope of insurance funds is widely
defined under PRC law, consisting of
capital funds, capital and surplus reserves,
undistributed profits, all kinds of otherreserves and other funds of insurers under
the relevant regulations.42 We consider inthis annex:(a) Life insurance. The insurer undertakes,
in consideration of a specific premium
being paid, to pay out a lump sum or fixed
regular income on the insured’s death oranother defined event. The main purposeof this policy is investment. Life insurance
policies are divided into three types,
according to the profits generated fromthe investment return from the premium
paid by the relevant policyholder to whichsuch policyholder is entitled:43
(i)

(ii)

2.4.2

2.4.3

the premium multiplied by afixed interest rate (compoundedannually), where the insurer bears all
investment risk;
the premium multiplied by aguaranteed minimum interest rate(compounded annually) plus dividends(if any) generated from the investment
return (declared monthly or quarterly),
where the insurer and the policyholder
share the investment risk; and(iii) the dividends (if any) generated fromthe investment return (declaredat least once a week), where theinvestment risk is entirely borne by
the policyholder.
(b) General insurance. This includes typesof insurance policies that are not life
insurance, including property, accident andsickness, travel and liability insurance. The

257

We have excluded from consideration“non-life investment insurance” that has
the same profit and risk sharing feature aslife insurance policies but over a shortertime span (usually one to three years). It
has been removed from the market due torisk concerns.

2.4.4

Key terms and conditions of thepolicyholder documentation (including
the actuarial report and other ancillarysupportive documents) and any
subsequent amendments thereto must be
submitted to the regulatory authorities
for approval before implementation.44
For life insurance policies where thepolicyholders share or solely bear theinvestment risk, policyholders will
select the notional “units” they wish
to “purchase” with their premiumfrom a range of funds made available
by the insurance company. Returns
payable to the relevant policyholder
reflect the performance of the fundheld and managed by the insurer inconnection with those “units” based on
the entrustment arrangements, as all
insurance policies are contract-based.45
Insurers can either make investments
themselves or appoint Investment
Managers to manage the portfolio.46
The key entities are:
• Asset Owners: insurers.
• Beneficiaries: natural or legal persons whoare entitled to benefit under the policy,
including policyholders, dependents,
employees, etc. For the purpose ofthis annex, we are also treating thecurrent shareholders47 of the insurers as“beneficiaries” due to their economic interestin the management of the insurer’s assets.
• Investment decision-makers: insurers, orInvestment Managers appointed by insurers.
Overview of investment duties and powers

48

2.4.5

Typically, an insurer’s investment duties
are shaped by:(a) special laws and regulations regarding theadministration and operation of insurance
funds, which notably specify that:49(i)the purpose of the investment
of insurance funds is to achieve
long-termism, value investing anddecentralized investment for the
insurance industry;50(ii) the funds should establish andimplement investment strategies andannual asset allocation plans;

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Australia

Brazil(iii) the funds should comply withportfolio diversification requirements
and investment restrictions;

Canada(iv) business should be conductedconducted with honestly, good faith,
prudence and safety;

European Union(v)

where one or more Investment
Managers are appointed, there should
be no diversion of insurance profits orillegal transmission of interests, andno request for guaranteed revenue by
the Investment Manager(s);(b) the terms of policyholder documentation
similar to obligations under the laws
and regulations, albeit with
supplementary information:(i)insurance name, term, premium rates
and benefits;

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policies, business plan and estimatedimpact on solvency;• for equity investment, target companies

must comply with national industrial
policies, and not be big energy consumers
or polluters;52(c) contract law and agency duties owed
to the policyholders arising out of theentrustment arrangements (Section
2.2.8(c)); and• for equity investment in the long-term

rental market, target projects must havepositive economic and social benefits;53(d) the insurer’s directors and senior
management’s duty of loyalty and care
under company law to the shareholders
and external creditors (Section 2.2.10).
2.4.6

The standard of insurer’s duties ofhonesty, good faith, prudence anddiligence to the policyholders arisingout of special laws or the contract-based
entrustment arrangements has not been
explicitly established under PRC laws.
In practice, it is usually understood tobe similar to that of the fiduciary duties
of loyalty and care of the directors andsenior management of a Chinese company(Section 2.2.10) with certain deviations
where justified. However, the exact scopeof such permitted deviations has notbeen established in practice in respect ofachieving a (particular) financial returnor IFSI.

General insurance: legal requirements to use
investment powers to IFSI
2.4.7

2.4.8

258

We do not consider insurers to be underan express general duty to IFSI (either
instrumental or ultimate-ends IFSI) for
reasons similar to those mentioned in
Section 2.2.13.
However, there are special requirements
in relation to the investment of insurance
funds in certain sectors or areas that havethe effect of requiring ultimate-ends IFSI.51
These supersede insurers’ other duties andliabilities under the insurance policies or
to shareholders. For example:• for investments via collective trusts,

target projects or target enterprises
must comply with general national andindustrial policies;54• for debt investment, target projects musthave a positive social effect and comply
with national and local industry, land,
environmental protection, energy saving
and other policies; and55• for the acquisition of listed companies

with other parties, the targets mustcomply with national industrial policies,
not be big energy consumers or polluters,
meet the state’s energy-saving andenvironmental protection standards, ornot be of low technical standards.56
2.4.9

If a general insurer is a listed company, it
is required to bear greater general social
responsibilities, including the following,57
without guidance on what this entails:58(a) to actively practice the concept ofsustainable development, add theecological and environmental protection
requirements into strategy development
and corporate governance processes,
actively participate in the constructionof ecological civilization, and play an
exemplary and leading role in pollution
prevention, resource conservation andecological protection; and(b) to be socially responsible in terms ofcommunity welfare, disaster relief,
public welfare, etc., while maintaining
sustainable development, improving
operating performance and protecting
shareholder’s interests.
It is also encouraged to support poor
counties or villages, support industrial
development in poor areas, nurture talentand promote employment. However, it isunclear how these obligations interact with
the insurers’ other duties and obligations
under insurance policies or to shareholders.
General insurance: legal freedom to use investment
powers to IFSI
2.4.10 We consider that, in addition to therequirements referred to above, theapplicable legal rules offer some flexibility
for general insurers to IFSI (including
ultimate-ends IFSI), provided that theoutcome is at least comparable to thatof a similar portfolio managed by aprudent third-party professional and not
significantly less than could have beenachieved without IFSI.
2.4.11 Listed insurers are encouraged to publish
an annual social responsibility report59
and are subject to the mandatory
disclosure of major events related toenvironmental protection. However,disclosed events are those of the insurers
or their consolidated subsidiaries, andthe investments made by insurers withinsurance funds or the underlying assets
do not fall into the scope of disclosure,since they represent minority stakes as aresult of the diversification requirements.
Therefore, we do not think listed
insurers are under pressure to disclose
environmental information relating totheir sustainability impact.

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Life insurance: legal requirements to use investment
powers to IFSIACKNOWLEDGEMENTS

2.4.12 We do not consider life insurers to beunder an express general duty to IFSI
(either instrumental or ultimate-ends IFSI)
for the same reasons as general insurance
although the exception of the special
statutory requirements (Sections 2.4.7 to
2.4.9) also applies to life insurers.

EXECUTIVE SUMMARY

Life insurance: legal freedom to use investment
powers to IFSI
2.4.13 Even for life insurance policies where
the policyholders share or solely bear
the investment risk, we do not consider
that there is an over-arching duty under
PRC law for the life insurer to pursue aparticular financial return which excludes
any possibility of managing the fund toachieve any other goals such as ultimateends IFSI, due to the lack of statutory
duties of insurers (eg loyalty and diligence)
explicitly requiring the insurers to do so.
2.4.14 We consider that the applicable legal rules
allow some flexibility for life insurers to
IFSI (including ultimate-ends IFSI) for thesame reasons and to the same extent as
general insurers (Sections 2.4.10 and 2.4.11).

A. INVESTING FORSUSTAINABILITY IMPACT

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3.

ASSET OWNERS’ USE OF THEIR POSITION TO ENGAGE IN STEWARDSHIP ACTIVITIES TO SECURESUSTAINABILITY IMPACT

3.1

The following section considers the extent
to which, and on what basis, each typeof Asset Owner is required, or permitted
or able, to use its position to influence
enterprises in which it invests by engaging
in stewardship activities designed to achieve
positive sustainability outcomes andminimize negative sustainability outcomes.

3.1.3

Overarching considerations
3.1.1

3.1.2

260

There is no specific legislation under PRC
law on Asset Owners’ powers and duties
to carry out stewardship or engagement
activities (like the stewardship code of theUK, Japan or other jurisdictions). Nor does
PRC law impose a duty on Asset Owners towork collaboratively to address systemic(non-portfolio/issuer-specific) risk on the
future performance of the target assets or
issuer. Furthermore, insurers and publicfunds managers are generally required touse the rights attached to the instruments
in which they have invested60 to protect
beneficiaries’ interests, but this does
not necessarily require them to engage
in stewardship activities. Therefore, in
general, Asset Owners’ investment duties
and powers regarding stewardship will be
shaped by the same considerations as set
out in the “Overview of investment duties andpowers” in Section 2.
The costs incurred by stewardship
activities are not explicitly allocated bylaw, so it is unclear who would bear thecosts of stewardship activities. Therefore,
we see possible disputes between
beneficiaries and Asset Owners if any
stewardship activities do not generate
short-term financial returns to at least
offset the costs.

3.1.4

3.1.5

Having regards to investment
diversification requirements61 and withlimited implementation of cumulative
voting and proxy solicitation, which
are available in listed companies andnon-listed public companies only, Asset
Owners may not be able to hold a stake inthe underlying assets that is significant
enough to exercise stewardship activities.
A best practice for the stewardship
activities of Asset Owners and otherinstitutional investors in respect oflisted securities was introduced under
PRC law in 2018. It encourages (but does
not require) Asset Owners to (a) actively
participate in the governance of listedcompanies by exercising shareholder’srights (eg the right to vote, to informationand to make a proposal) and via theirdelegates (ie directors and supervisors),and (b) publicly announce their objectives
and principles of corporate governance,
strategies adopted for exercising voting
rights, and records and outcome of
exercising shareholder’s rights.62
There is no law or regulation explicitly
prohibiting Asset Owners fromcollaborating with others for stewardship
activities, however, there may be material
impediments or deterrents to cooperationof this sort, including:(a) Competition law. Collaboration between
competitors amounting to price fixing,
output or sales restrictions, sharing ofmarkets and customers, joint restrictions
on new products or technology, or
collective boycotts, will virtually
never be permitted.63 A collaborative
arrangement involving the exchange

of information or the coordination ofcommercial activities may also infringe
competition law if it eliminates or
restricts competition or is considered
to facilitate or lead to any of the abovementioned infringements. Chinesecompetition law provides an exemption
for collaboration arrangements that are
intended to realize public interests suchas energy efficiency and conservation,
environment protection, and the provisionof disaster relief and assistance,64 which
may concern joint efforts designed toachieve sustainability impact. Exempt
arrangements must also allow consumers
a fair share of the resulting benefits,
and must not significantly restrict
competition in the market.65 However,as of today, China’s competition
authority has not yet published any
decision granting an exemption
for such collaborations. No priornotification or application for exemption
to China’s competition authority isrequired. Parties can implement thecollaboration arrangements if, basedon a self-assessment, they consider
that the arrangement is eligible for
exemption. If the authority initiates
an antitrust investigation, the parties
must provide evidence demonstrating
actual or intended realization of public
interests, consumer benefits as well as no
significant adverse impact on competition.
In general, collaboration for non-binding
and non individualized sustainability
targets or exchanging high-level bestpractice insights are less likely to giverise to competition issues, provided thatsuch collaborative actions do not facilitate

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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CONTENTSFOREWORDSINTRODUCTION(e) Mandatory tender offer. Collective
shareholder action may trigger therequirement to make a mandatory tender
offer to acquire listed securities fromother shareholders or infringe restrictions
in place during certain periods.70

or lead to any of the aforementioned
infringements and competitively sensitive
information must not be exchanged.
(b) Merger control. Collaboration between Asset
Owners can potentially trigger a merger
filing obligation under China’s merger
control regime. If Asset Owners reachan agreement on how to exercise theirvoting rights due to their collaboration forsustainability impact, these Asset Owners
could be treated as concerted entities acting
as one party. Depending on their aggregatedvoting rights, the matters on which theyagree to act in concert and the corporate
governance structure prior to and post thecollaboration, these Asset Owners acting
as one party may be regarded as jointly
obtaining control over the invested company
from the perspective of Chinese competition
law via their collaboration arrangements.66
Such collaboration will be subject to amerger control filing in China if these Asset
Owners meet the filing thresholds, which
are based on the parties’ global and PRC
turnover. Thus a detailed assessment of thenotifiability of such collaborations should bemade before implementation.
(c) Reporting requirements. Collective
shareholder action in respect of listed
securities may trigger reporting
requirements regarding combined
shareholdings.67 In particular, insurers are
subject to special disclosure requirements
when acquiring listed companies withother parties acting in concert.68(d) Insider and short-swing trading. Shareholders
acting in concert may become insiders
thus subject to relevant obligations/
restrictions, including disgorging any
profits made from the purchase and saleof securities where both transactions
occur within a short time frame.69
261

3.2

3.4

3.4.1

Pension funds

Legal requirements to engage forsustainability impact
3.2.1

For the reasons set out in Section 2.2.13,
and subject to the caveats in Section
2.2.14, we do not consider that pension
fund trustees are generally subject to an
express duty to engage in stewardship
activities for sustainability impact.

Insurance undertakings

General insurance: legal requirements to engage forsustainability impact
Subject to the general obstacles in Section
3.1 and for the reasons set out in Sections
2.4.7 to 2.4.9, we consider that generalinsurers are subject to a duty in specificcases to engage in stewardship activities
for sustainability impact if the investee
later engages in poor sustainability
practices (Section 2.4.8) although, fromthe wording of the legislation, insurers
are simply required to avoid investing incompanies that fail to meet the standards.

Legal freedom to engage for sustainability impact

General insurance: legal freedom to engage forsustainability impact

3.2.2

3.4.2

3.3

Subject to the general obstacles in
Section 3.1 and for the reason set out
in Section 2.2.15, in our view there issome flexibility for pension fund trustees
to engage in stewardship activities forsustainability impact.
Mutual funds

Legal requirements to engage forsustainability impact
3.3.1

Life insurance: legal requirements to engage forsustainability impact
3.4.3

For the reasons set out in Section 2.3.10
and subject to the caveats in Section
2.3.11, we do not consider that publicfund managers are generally subject toan express duty to engage in stewardship
activities for sustainability impact.

Legal freedom to engage for sustainability impact
3.3.2

Subject to the general obstacles in Section
3.1 and for the reason set out in Section
2.3.12, in our view there is some flexibility
for trustees to engage in stewardship
activities for sustainability impact.

Subject to the general obstacles in Section
3.1 and for the reason set out in Section
2.4.10, in our view, there is some flexibility
for trustees to engage in stewardship
activities for sustainability impact.

Subject to the general obstacles in Section
3.1 and for the reasons set out in Section
2.4.12, we consider that life insurers
are subject to a duty in specific cases
to engage in stewardship activities forsustainability impact if the investee later
engages in poor sustainability practices(Section 2.4.8) although from the wordingof the legislation, insurers are simply
required to avoid investing in companies
that fail to meet the standards.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

Life insurance: Legal freedom to engage forsustainability impact

GLOSSARY

3.4.4

REFERENCES

For the reason set out in Section 2.4.14,
in our view, there is some flexibility forthe trustees to engage in stewardship
activities for sustainability impact.

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4.

ASSET OWNERS’ ENGAGEMENT IN PUBLIC POLICY WORK TO SECURE SUSTAINABILITY IMPACT

4.1

The following section considers the extent
to which, and on what basis, each type ofAsset Owner is required, or permitted orable, to use its position to engage in public
policy work designed to achieve positive
sustainability outcomes and minimize
negative sustainability outcomes, forexample, where these are relevant to thevalue of portfolio assets.

Overarching considerations
4.1.1

There is no specific legislation under PRC
law in respect of Asset Owners’ powers
and duties to carry out public policy
work activities. We are not aware of any
duties or powers regarding public policy
work activities shaped by other principles
and legal rules. Asset Owners engaging
in public policy work for sustainability
impact should act on their own behalfand be funded from their own resources
to avoid being accused of misuse of fundassets as participation in public policy
work is in general too remote to bedeemed as one of the commonly accepted
areas of fund activity in China.

4.2

Pension funds

4.2.1

For the reasons set out in Section 4.1.1,
we consider that trustees are generally
not obliged but have the legal freedom,
subject to the considerations mentioned
in Section 4.1.1, to engage in public policy
work activities for sustainability impact.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSI

4.3

Mutual funds

4.3.1

For the reasons set out in Section 4.1.1, we
consider that public fund managers are
generally not obliged but have the legal
freedom, subject to the considerations
mentioned in Section 4.1.1, to engage
in public policy work activities forsustainability impact.

C. AREAS FOR LEGAL REFORM

4.4

Insurance undertakings

JURISDICTION REPORTS

4.4.1

For the reasons set out in Section 4.1.1,
we consider that insurers are generally
not obliged but have the legal freedom,
subject to the considerations mentioned
in Section 4.1.1, to engage in public policy
work activities for sustainability impact.

ANNEXES
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5.

ESTABLISHING NEW FUNDS TO IFSI AND AMENDING THE TERMS OF EXISTING ONES

5.1

The following section considers theextent to which it is possible for an Asset
Owner to set up a fund, policy or otherproduct with the express objective of IFSI
(especially ultimate-ends IFSI).

5.2

5.2.3

Pension funds

Public schemes
5.2.1

Public schemes (ie the BPF and the NSSF)
are sovereign funds, established andregulated by statutory rules (Section 2.2.1).
The trustees have no authority to set
up a new fund of this sort or amend theterms of existing ones with the express
objective to IFSI (either instrumental
or ultimate-ends IFSI). The lawmakers
or the government could amend therelevant objective in the relevant laws andregulations to incorporate sustainability
impact factors.

263

Theoretically speaking, we see no legal
prohibition on establishing private schemesthat incorporate sustainability impact
objectives under PRC law as the fundobjective can be separately agreed by theparties. Although the trustees are retainedby the employers and employees of private
funds, directly or through statutory agent
in the case of the OAF,71 to manage theinvestment and operation of fund assets,
the fund documentation is preparedby the employers and employees alone(Section 2.2.7(a)). The trustees thus haveno authority to set up a new fund of thissort or amend the terms of existing ones
with the express objective to IFSI (either
instrumental IFSI or ultimate-ends IFSI).

those with the objective of ultimateends IFSI that is prioritized over or has
negative impact on financial performance)
may face the challenge that it is not ascompetitive in the market as funds withless or no focus on sustainability.
5.3.2

For existing public funds, however, as
the unitholders may amend the “keyterms” of the fund agreement(which
we believe should include the fundobjective) unilaterally via the unitholders’general meeting throughout the term of
the fund agreement (Section 2.3.4), thebeneficiaries’ wish to pursue sustainability
impact is still achievable by law.

Duties on those designing, manufacturing andproviding pensions

Duties on those designing, manufacturing and providing
mutual funds

5.2.4

5.3.3

Private schemes
5.2.2

That said, as private schemes are highly
regulated and their fund documentation(including subsequent amendments
thereto) should strictly follow the official
templates and be filed with the authorities
before adoption, the fund objective islikely to be financial only (eg “appropriate
profitability” as provided in the official
template) (Section 2.2.11). The authorities
could challenge private schemes thathave IFSI (especially ultimate-ends IFSI)
as an express objective, which calls into
question the feasibility of setting up ascheme or amending an existing one withsuch an objective in practice.

As the beneficiaries of a private scheme(eg the employees) are responsible forformulating the fund plan, their wish to
pursue sustainability impact should bereflected therein, and there is no duty or
obligation for the trustees to inquire into
the beneficiaries’ wishes under PRC law.
The express objective of IFSI (including
ultimate-ends IFSI) can be defined whena new fund is set up, or on a continuous
basis by amending the terms of an existing
fund pursuant to the statutory rules.

5.3

Mutual funds

5.3.1

We see no legal prohibition on
establishing mutual funds to incorporate
sustainability impact as a primary or
secondary objective under PRC law.
However, as the benchmarks commonlyused in rating public fund performanceare short- or medium-term financial
return and the fund objective should be
publicly disclosed before any offering(Section 2.3.12), such funds (particularly

We see no legal duty for public fundmanagers to design, create or operate mutual
funds by reference to the wishes or needs ofa “target market” or relevant beneficiaries.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanada5.4Life insurance products

China

5.4.1

We see no legal prohibition on
establishing products with investment
objectives which seek to IFSI (either
instrumental or ultimate-ends IFSI) under
PRC law. However, as life insurance
products must follow insurance productdevelopment guidelines,72 be approvedby the authorities (Section 2.4.2) andmeet risk control-associated technicalrequirements,73 insurers may facetechnical challenges in practice inestablishing a new product with theexpress objective of IFSI (especiallyultimate-ends IFSI).

European Union

5.4.2

The process of amending terms of existingproducts in order to set the express
objective of IFSI (especially ultimate-ends
IFSI) may face the same practical challenges

FranceJapan

Netherlands

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United Kingdom
United States

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CONTENTSFOREWORDSINTRODUCTION

as new products in respect of productdesign, operational requirements andapproval by the authorities for subsequentchanges to policyholder documentation.
Duties on those designing, manufacturing andproviding life insurance products
5.4.3

We see no legal duty on insurers to design,
create or operate life insurance products
by reference to the wishes or needs of a“target market” or relevant beneficiaries.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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6.

INVESTMENT MANAGERS’ DUTIES TO IFSI

6.1

This section considers the extent to which,and in what circumstances, an Investment
Manager is required or permitted to IFSI
on behalf of an Asset Owner or otherwise,in each of the three ways contemplated in
Sections 2 to 4.

6.1.2

Powers of investment and divestment
6.1.1

Typically, an Investment Manager’s
investment duties and powers are shaped by:(a) specific laws and regulations74 regarding
investment portfolio management, whichnotably specify:(i)investing fund assets in accordancewith the investment managementagreement (IMA);(ii) conducting business with honesty,
good faith, prudence and diligence;(iii) no guaranteed financial return orcompensation for losses;

6.2

6.2.1

no commingling of fund assets with
its own assets; no seeking of improper
benefits for others by taking
advantage of the fund assets; and noembezzlement or misappropriation offund assets;(b) the terms of the IMA with an Asset Owner,
which typically specify:(i)the objective, scope, term andrestrictions of the investment;(ii) key personnel, conflicts of interest,
risk control, information disclosure,divestment, etc.; and(c) contract law and agency duties owed
to Asset Owners arising out of the IMA(Section 2.2.8(c)).
265

The standard of Investment Managers’
duties of honesty, good faith, prudence anddiligence to Asset Owners arising out ofspecific laws or contract-based entrustment
arrangements has not been explicitly
established under PRC laws. In practice, it
is usually understood to be similar to thatof the fiduciary duties of loyalty and careof the directors and senior managementof a Chinese company (Section 2.2.10)
with certain deviations where justified.
However, the exact scope of such permitted
deviations has not been establishedin practice in respect of achieving a(particular) financial return or IFSI.

6.2.3

Legal obligations with respect tosustainability impact

6.2.5

6.2.2

Where the IMA or relevant laws andregulations (such as specific regulatory
requirements on general and life insurers’
investment (see above Sections 2.4.8 and2.4.12)) require IFSI (either instrumental
or ultimate-ends IFSI), the Investment
Manager must pursue a strategy thatcomplies with such requirements.
Investment Managers will want to ensurethat the mandate specifies how any
sustainability impact objectives should
be balanced with financial objectives tominimize complaints and litigation risk.
Where the mandate is silent as tosustainability impact, we do not consider
that an Investment Manager would
be subject to a duty to IFSI (either
instrumental or ultimate-ends IFSI) unlessthe mandate is subject to the statutory
requirements, for example, relating toan insurance fund having the effect of
requiring IFSI (Section 2.4.8).

If the Asset Owner wishes to incorporate
IFSI (including ultimate-ends IFSI) as aninvestment objective, the IMA should be
amended to incorporate this.

Engagement to achieve sustainability impact
6.2.4

As for powers of investment or divestment,
an Investment Manager’s duties would
follow the terms of its mandate. Where
the mandate is silent as to sustainability
impact, we do not consider there to be any
legal requirement for Investment Managers
to engage with portfolio companies toachieve sustainability impact.

Public policy work to achieve sustainability impact

Powers of investment and divestment(iv) fair treatment of the fund assets
and other assets under management(Section 2.2.8(a)(vi)); and(v)

ACKNOWLEDGEMENTS

6.3

As above, an Investment Manager’s duties
would follow the terms of its mandate.
Where the mandate is silent as tosustainability impact, we do not consider
there to be any legal requirement for
Investment Managers to engage in public
policy work to IFSI (either instrumental or
ultimate-ends IFSI).
Legal freedom to invest for IFSIPowers of investment and divestment
6.3.1

6.3.2

Where the IMA is silent on IFSI (either
instrumental or ultimate-ends IFSI), we
consider that the applicable legal rules
allow some flexibility for Investment
Managers to exercise their investment
powers for sustainability impact, although
they will be reluctant to consider factors
additional to financial returns without
clear instructions to do so as it may expose
them to litigation risk if the practicaloutcome is reduced financial returns.
Investment Managers are not generally
obliged to offer sustainability-focused
products to Asset Owners but are free todo so.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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6.3.3

The Investment Manager and Asset Owner
could agree to amend the terms of an
existing IMA to IFSI (including ultimateends IFSI). There are no limitations on
the Investment Manager’s ability to doso, but Asset Owners’ ability to agree
to such changes will be limited bytheir obligations to their beneficiaries(as discussed above) and so in manycases such an amendment may not bepractically possible.

Engagement to achieve sustainability impact
6.3.4

6.3.5

6.3.6

266

Since stewardship activities are less likely
to affect the composition of an investment
portfolio, there may be more scope topursue sustainability impact throughstewardship activities, even where the
IMA is silent upon the point.
In the absence of instruction on suchengagement, the short-term nature ofmany IMA investment horizons may
reduce the flexibility for engagement
for sustainability impact if it will reduce
financial returns over the relevant time
horizon. However, there may exist atension with the long-term nature of otherportfolios (such as for pension funds andlife insurance companies), which may
increase the flexibility for engagement
due to the possibility of sustainability
impacts adversely affecting financial
performance in the medium to long term
(Section 2.2.14).
An Investment Manager is unlikely toengage for sustainability impact where doing
so demonstrably costs the portfolio morethan it can return as it is unclear under thelaw which party shall bear the costs.

Public policy work to achieve sustainability impact
6.3.7

An Investment Manager is broadly free toengage in public policy work on its own
behalf, funded from its own resources
subject to any conflict of interests.

6.3.8

In the absence of instruction on suchengagement, the short-term nature ofmany IMA investment horizons may reduce
flexibility for engagement in public policy
work to achieve sustainability impact if it
reduces financial returns over the relevanttime horizon. However, there may exista tension with the long-term nature ofother portfolios (such as for pension funds
and life insurance companies), which may
increase the flexibility for engagement due
to the possibility of sustainability impacts
adversely affecting financial performance inthe medium to long term (Section 2.2.14).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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7.

LEGAL LIABILITY TO THIRD PARTIES FOR THE NEGATIVE SUSTAINABILITY IMPACT OF
ENTERPRISES IN WHICH PORTFOLIOS ARE INVESTED

7.1

This section considers the extent to which,regardless of the legal rules under which itis required to operate and its constitution,
an Asset Owner could be legally liable tothird parties for the negative sustainability
impact of enterprises in which it invests,
and whether an Investment Manager could
also be liable because of its role in assisting
the Asset Owner to invest in the relevant
enterprise and steward its investment.

7.2

Asset Owners

7.2.1

An Asset Owner would generally not
be subject to civil, administrative or
criminal liability75 for the negative
sustainability impact of an investee entity/
project solely by virtue of its fundingof such an entity/project. It would only
be subject to criminal liability if it was
regarded as acting as a conspirator incommitting a crime,76 which is rare inpractice. A conspirator means someone
who has jointly committed a crime undera conspiracy, depending on specificcircumstances, as a principal offender,an accomplice, a coerced offender or an
instigator,77 but we see no case under PRC
law that merely (minority) funding anactivity might be assessed criminally.

7.2.2

267

Where the corporation is held criminallyliable, the personnel directly in charge ofthe criminal offences of the corporation
may also face criminal charges.78 As
such, a delegate (eg director) in theinvestee appointed by an Asset Owner
may personally face criminal liability if
the delegate takes charge of the investeeor otherwise is directly responsible forany negative sustainability impact thatamounts to a criminal offence. “Directly

responsible” for an offence is commonlyinterpreted as the employees carrying out
the action giving rise to the offence, and“directly in charge” is mainly regarded as
the immediate supervisor of the foregoing
employees or the direct decision-maker.
7.3

Investment Managers

7.3.1

The same considerations as set out in
Section 7.2. would apply.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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8.

THE GROWING IMPORTANCE OF TAKING ACCOUNT OF ESG FACTORS WHERE THESE ARE‘FINANCIALLY MATERIAL’

8.1

It has become increasingly importantfor Asset Owners and their managers
to take ESG factors into account whenmanaging portfolios because of theway in which they could impact theirinvestment objectives. The main reasonsare summarized below.

8.2

8.3

268

In addition to the official guidelines
referred to in Section 1.9, a numberof industrial policies promoting thedevelopment of sustainability impactrelated sectors have been released as well.
For example, Made in China 2025, the toplevel manufacturing policy issued by theState Council in May 2015, aims to build asustainable manufacturing sector, which
includes developing eco-friendly projects
and reducing pollution.
Commercial enterprises are gradually
disclosing more information about
their ESG performance. For example,
the Measures for the Disclosure ofEnvironmental Information by Enterprises
and Public Institutions79 issued by the
Ministry of Environmental Protection in
December 2014 mandated that enterprises
producing significant pollution shalldisclose environmental information,
including information related to pollution
produced by them. The Shanghai Securities
Exchange (SSE) encourages listed companies
to publish annual social responsibility
reports – those listed companies that do so
benefit from simplified temporary noticereview procedures. SSE also issued the
Guidelines of Environmental Information
Disclosure by Listed Companies in May
2005, which require, among others, that
listed companies should disclose major
events related to environmental protection.

8.4

Financial products that are issued to raisemoney for eco-friendly industries arenow subject to more relaxed regulatory
requirements. For example, the National
Development and Reform Commission
issued the Guidelines of Issuance of Green
Bonds in December 2015, which has
multiple policies that benefit the issuersof sustainable bonds, including providing
governmental subsidy and relaxing generalbond-issuing regulatory requirements.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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9.

THE MEANING OF “FINANCIALLY MATERIAL”

9.1

Because of the growing importance oftaking ESG factors into account in theinvestment process where financiallymaterial, it is important to understandhow the law defines what is “financiallymaterial” and the period by reference
to which financial materiality must
be measured. Taking account ofsustainability factors that are financiallymaterial in order to pursue financial
objectives may incidentally havesustainability impacts and may also be
consistent with IFSI. However, beyond thatpoint, any attempt to realize a positive
sustainability impact might need to rely
solely upon IFSI (ie because it would nolonger be driven by the need to generate
financial returns).

9.2

Financial materiality

9.2.1

There is no provision under PRC law or
guidance expressly addressing this matter.
However, as the notion of “financial
materiality” has been commonlyreferred to in various contexts relating
to investment activities, we understandthat the need to take into account thesustainability impact when seeking tosecure a financial return depends on andis proportionate to the extent to whichsuch a sustainability impact will affect theportfolio in specific cases. For example:(a) the Administration Measures ofInformation Disclosure of Listed
Companies provide that listed companies
shall disclose any information that will
have material impacts on investors’
investment decision-making; and/or(b) the Administration Measures ofthe Material Asset Restructuring ofListed Companies provide detailed
ratio standards to ascertain whether
a transaction qualifies as a material
asset restructuring, as the listedcompanies generally bear greater social
responsibilities (Section 2.4.9).
9.3

Time period by reference to which“materiality” is to be assessed

9.3.1

There is no provision under PRC law or
guidance on this. Thus, we assume that
only the “investment horizon” of therespective beneficiaries is relevant here.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Amber Liu, Yuxin Shen and Wang Zhe
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1
2

3

If a sustainability objective is expressly stated, there will be acorresponding duty to IFSI in order to achieve this objective.
In contrast to the common law concept of trust where the title ofthe underlying assets is transferred to the trustee, trusts under PRC
law fall into the broader scope of contractual relationships, which are
however regulated in accordance with trust law instead of contract
law. (It is not well established under PRC law whether trusts are
regulated by contract law, and further, by the superordinate conceptof the contract-based entrustment arrangement.) Trusts also sit at
the intersection with the property law – the assets are controlled by
the trustee based on the psychological trust between the trustee
and the grantor, and the trustee manages the assets in its own
name.
The major difference in respect of the duties and obligations
owed by an Asset Owner between a trust and a contractual-based
entrustment arrangement is the degree of authority for managing
the underlying assets. While the Asset Owner of a trust fund has theauthority to manage the fund at its discretion based on the trust
arrangement, the Asset Owner of a contractual-based entrustment
arrangement must act strictly within the terms of the underlying
entrustment agreement (although this could grant the Asset Owner
authority that is comparable to a trustee’s).
Except for the judicial interpretations and guiding cases of theSupreme People’s Court of China, which constitute part of hard law,precedent cases have no binding effect under PRC law. They may
serve as an illustration of the common view in practice of complying
with the relevant rules, but they cannot help predicting the outcomeof future cases even though there are existing cases addressing thesame issue.

4

http://opinion.people.com.cn/n1/2018/1112/c1003-30395901.html

5

The politburo of the CCP is the party’s decision-making body.
Currently, it is a group of 25 top officials who oversee the CCP. Power
within the politburo is further centralized in its standing committee,
a smaller group of politburo members.

6

7

8

9

270

Elements of natural ecology together with the environment (egmountains and ground, land and sea, upstream and downstreamof drainage area) should be taken into consideration andoverall protection, systemic maintenance, and comprehensive
management should be carried out according to the integrity,
systematic workings and internal rules of the ecosystem.
The Green Financing System Guidelines promote the establishmentof a sustainable financial system in China by bringing moreprivate capital into the “green” economy, developing an ecologicalcivilization, and sending a positive signal on sustainability to themarket. The Climate Investment and Financing Guidelines propose
several measures to encourage private investment in areas related
to climate change, including laying down a regulatory framework,
formulating relevant national standards (eg standards for climaterelated projects and the disclosure of climate-related information),
guiding and supporting local practices, and advancing international
cooperation.
Insurance Asset Management Association of China (the IAMAC),
the self-regulatory body of China’s insurance industry, publishedthe Proposal for Green Investment in China’s Insurance AssetManagement Sector (the Green Insurance Investment Proposal)
in June 2018. The Green Insurance Investment Proposal at a highlevel encourages insurers and Investment Managers of insurance
funds to explore various investment instruments, establish industrial
standards, enhance investment capabilities, prevent and control
risks, and strengthen international cooperation, in each case forsustainable investments with insurance funds.
Green Finance Committee of China Society for Finance andBanking (a sub-committee focusing on sustainable finance of afinancial academic society under the People’s Bank of China) andLondon Corporation’s Green Finance Initiative jointly published theGreen Investment Principles for the Belt and Road Initiative (theGIP) in November 2018. The GIP was prepared based on existing
responsible investment initiatives as a special version focusing on
the countries in the Belt and Road area, and strives to integrate
low-carbon and sustainable development principles into Belt andRoad construction projects while still meeting the huge demand forinfrastructure development along the region.
10

Asset Management Association of China (the AMAC), the associationand self-regulatory body of China’s investment fund industry,
published Green Investment Guidelines (the GIG) in December
2019. “Green investment” refers to the investment strategy with theobjective of environmental sustainability. The GIG encourages fundmanagers, especially those providing investment management
services to pension funds, insurance funds and funds for social andpublic interest to establish a management system for sustainable
investment, make sustainable investments and work with target
enterprises with a focus on environment-related performance andthe disclosure of environment-related information.

11

Article 5 of the Regulation on the National Social Security Fund.

12

Article 4 of the Social Insurance Law.

13

The key laws and regulations are:(i) BPF: the Social Security Law and relevant implementing
provisions, the Measures for the Administration of Investment in
Basic Pension Fund and regulatory rules issued by the provincial
governments; andissued by provincial governments; and(ii) EAF: the Measures for Enterprise Annuity Funds and the Measures
for the Management of Enterprise Annuity Funds.
25

http://www.amac.org.cn/researchstatistics/datastatistics/
mutualfundindustrydata

26

Article 68 of the Securities Investment Fund Law.

27		These matters include (i) material changes of investment objective,
scope, policies or return and risk; (ii) material changes of rules ofredemption or subscription, valuation and verification, rate structure,etc., and (iii) other changes that may disqualify the public funds.
28

These matters include (i) to raise extra funds or to extend the termof the fund agreement; (ii) to amend or to terminate the fundagreement, prior to the expiry date; (iii) to replace the public fundmanager and the custodian; (iv) to determine the management feesof the public fund manager and the custodian; and (v) other powers
and functions as provided in the fund agreement.

29

Articles 47 and 49 of the Securities Investment Fund Law, and Article
40 of the Measures for the Administration of the Operations of
Publicly Offered Securities Investment Funds.

30

Article 24 of the Guiding Opinions on Internal Control of Securities
Investment Fund Management Companies.

31

According to the Guiding Opinions of the People’s Republic
Bank of China, the China Banking and Insurance Regulatory
Commission, the China Securities Regulatory Commission, and theState Administration of Foreign Exchange on Regulating the AssetManagement Business of Financial Institutions (the New AssetManagement Provisions) issued and effective on 27 April 2018,
the framework and principles regarding systematic vulnerability of
the asset management industry shall include, among others, (i) no
guaranteed income/principal provided by fund managers to thestakeholders; (ii) fund managers to operate and manage fund assets
with the duties of loyalty and diligence; and (iii) no pooled assets orleverage under the schemes.

(ii) NSSF: the Regulations on the National Social Security Fund,the Interim Administration Measures of Investment by the
National Social Security Fund, and the Interim Provisions on the
Administration of Overseas Investment by the National Social
Security Fund.
14

Article 4 of the Interim Measures for the Investment Managementof National Social Security Funds, Article 1 of the Regulation on the
National Social Security Fund, and Article 3 of the Interim Measures
for the Investment Management of National Social Security Funds.

15

Paragraph 2 of Article 6 of the Regulation on the National Social
Security Fund.

16

The portfolio diversification requirements mainly focus on the
categories (eg listed/unlisted stocks, bonds, financial derivatives, etc.
of well-developed/emerging markets) and balance (eg a cappedamount of fund assets invested in a single category) of the target
assets.

17“No unfair treatment of fund assets with assets of other funds underthe management or within the same fund” is the literal translationof the legal provisions, which means the fair treatment of thebeneficiaries as represented by their fund assets.

18

Chapter 7 of Part I of the Civil Code.

19

Chapter 23 of Part III of the Civil Code.

20

Articles 147, 148 and 149 of the Company Law.

21

There are discussions on the application of the individual-based testof duty of care, like the “business judgment rule.” We have also seena few cases in which the lower courts in less developed regions ofChina have followed this approach.

22

http://hrss.hainan.gov.cn/hrss/0900/201811/34621f88276c47f3
a7973ce70e5d3745.shtml

23

We are unable to find a template or sample fund plan of the OAF
from publicly available sources.

24

32

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
France33

2nd Civil Chamber of the Supreme People’s Court of China,
Understanding and Application of the Notice by the Supreme
People’s Court of Issuing the Minutes of the National Courts’ Civil andCommercial Trial Work Conference, 2019.

Japan

34

Under the civil law system, unlike the “absolute” rights (eg human lifeand health, ownership of property, IP rights, etc.), the infringementof contractual rights or pure economic interests is not remediable
under tort law, and the injured can only sue for breach of contract.
In practice, however, we see cases where some individual Chinese
courts granted remedies to the unitholders of public funds fordamages (including loss of expected earnings) due to public fundmanagers’ intentional act or gross negligence given the broadly
defined scope of rights and interests in paragraph 2 of Article 2 of
the Tort Law. We doubt the grounds for claiming tort in future cases,
and do not believe a damages claim is a remedy generally available
to the unitholders under PRC law.

South Africa

35

The key laws and regulations are the Securities Investment Fund
Law, the Measures for the Administration of the Operations of
Publicly Offered Securities Investment Funds, and the Measures
for the Administration of Securities Investment Fund Management
Companies.

36

Articles 25 to 30 of the Trust Law.

The key laws and regulations are:(i) OAF: the Measures for the Occupational Annuity Funds of State
Agencies and Public Institutions, the Interim Measures for theManagement of Occupational Annuity Funds and regulatory rules

According to the Notice by the Supreme People’s Court of Issuing
the Minutes of the National Courts’ Civil and Commercial Trial
Work Conference issued and effective on 8 November 2019, if theasset management business carried out by a financial institution
constitutes a trust pursuant to the New Asset Management
Provisions, disputes between the parties shall be handled inaccordance with the PRC Trust Law and other relevant regulations.

ACKNOWLEDGEMENTS

Netherlands

United Kingdom
United States

GLOSSARY
REFERENCES

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CONTENTSFOREWORDSINTRODUCTION
37

Clause 24, Section 2, Chapter 4, Part 2 of the Interpretation of theTrust Law, Law Press China, June 2002, http://www.npc.gov.cn/zgrdw/
npc/flsyywd/jingji/2003-11/14/content_324169.htm

38“Effectiveness” means literally, an efficiency-driven approach to
manage the underlying assets.

39

40

In practice, three years are considered a relatively long duration formutual fund evaluation in China. Before 2010, most ratings focusedon yearly performances. The Interim Measures for the Appraisal of
Securities Investment Funds now requires the rating agencies not toevaluate funds and fund managers with a duration of less than three
years.
The goal is “to draw fund managers’ attention to a fund’s ability
to generate sustainable returns, cultivate and guide investors’
understanding of long-term investment, and direct the developmentof the fund industry toward compliance and health.”

41

Paragraph 2 of Article 56 of the Securities Investment Fund Law.

42

Article 3 of the Measures for the Administration of the Utilization of
Insurance Funds.

43

The Notice of the China Banking and Insurance Regulatory
Commission, the Ministry of Finance, the Ministry of Human
Resources and Social Security, and the State Administration of
Taxation on Issuing the Guidelines on Developing Individual TaxDeferred Commercial Pension Products.

44

Article 4 of the Measures for the Administration of Insurance Clauses
and Insurance Premium Rates of Personal Insurance Companies,
and paragraph 2 of Article 4 of the Measures for the Administrationof the Insurance Clauses and Premium Rates of Property Insurance
Companies.

45

Article 10 of the Insurance Law.

46

According to the China Insurance Asset Management Development
Report 2018 published by the Insurance Asset Management
Association of China, around 80% of insurance funds are managed
by insurance assets management companies, around 17% byinternal investment department of the insurers, and the remainder
by other Investment Managers.

47

48

52

Article 12 of the Insurance Funds Equity Investment Measures.

53

Article 1(1) of the Notice of the China Banking and Insurance
Regulatory Commission on Matters concerning the Participation of
Insurance Funds in the Long-term Rental Market.

54

Article 4 of Notice of the General Office of the China Banking andInsurance Regulatory Commission on Matters concerning theInvestment in Collective Trust Funds with Insurance Funds.

55

Article 10 of the Interim Provisions on the Management of Debt
Investment Schemes in Infrastructure Facilities.

56

Article 7 of Notice of the China Insurance Regulatory Commission on
Matters concerning Further Strengthening the Regulation of Stock
Investments with Insurance Funds.

57

Articles 86 and 87 of the Code of Corporate Governance of Listed
Companies.

58

The 2018 amendment of the Code of Corporate Governance ofListed Companies imposes greater social responsibilities on listedcompanies as a result of the adoption of ESG and other concepts
advocated in international capital markets.

59

According to Article 5 of the Guidelines on Environmental
Information Disclosure of Listed Companies on the Shanghai
Stock Exchange, the matters to be disclosed in the annual social
responsibility report may be tailored by the listed companies
according to specific circumstances but shall include:(i) activities for promoting sustainable social development (egprotecting employees’ health and safety, protecting and supporting
local communities, and controlling product quality);(ii) activities for promoting environmental and ecological sustainability(eg preventing and reducing environmental pollution, protecting
water resources and energy, promoting local liveability, andprotecting and improving local biodiversity, etc.); and(iii) activities for promoting sustainable economic development (egcreating value for customers through its products and services,
creating better job opportunities, offering better training for workers,
and bringing high economic returns to its shareholders, etc.).

All insurers (both life insurers and general insurers) are required tobe established as limited liability companies under the Company
Law pursuant to Article 7 of the Provisions on the Administration of
Insurance Companies.

The Shenzhen Stock Exchange updated the Assessment Measureof Information Disclosure for Listed Companies on 4 September
2020. The updated version includes one sub-article under thesocial responsibility assessment article: “(to assess) whether thecompany proactively discloses environmental, social and governance(ESG) information, and whether information disclosed is accurate
and complete.” This is also included in the assessment table: if acompany discloses ESG information accurately it will get one point(out of a total of 100).

Potential restrictions on insurers’ powers and duties to use
investment powers to IFSI as a result of compliance with industrial
and operational requirements (eg SARMRA) is not considered in thisannex.

49		The key laws and regulations are the Insurance Law and relevant
implementation provisions and judicial interpretations, the Measures
for the Administration of the Utilization of Insurance Funds, theInterim Measures for the Administration of Oversea Investment
with Insurance Funds, the Interim Administration Measures for the
Entrusted Investment of Insurance Funds; the Interim Provisions on
the Administration of Insurance Assets Management Companies,
and specific regulations regarding investment in various target assets
with insurance funds.
50

Articles 4 and 45 of the Measures for the Administration of the
Utilization of Insurance Funds.

51

Since 2013, a series of policies related to environmental pollution
liability insurance have been issued, and the establishment of acompulsory liability insurance system for environmental pollution
in areas with high environmental risks was proposed in the Overall
Plan for Ecological Civilization System Reform and the Establishing
the Green Financing System. Echoing these policies and the social
responsibility of the insurance industry, insurance funds in generalshall not invest in enterprises or projects that do not comply with

271

national industrial policies, are big energy consumers or polluters,
fail to meet the state’s energy-saving and environmental protection
standards, or be with low technical standards.

60

61

The Insurance Funds Equity Investment Measures require theRelevant Investors of insurance funds to exercise their legal rights
and protect legitimate interests through legal and effective ways.
Specifically, where insurers take control of non-insurance financial
enterprises or enterprises whose business is connected to insurance,
they shall maintain control of the invested enterprises by appointing
directors, supervisors, management teams, or other key officers.
Further, the Securities Investment Fund Law requires public fundmanagers to take legal action (which is very broad under Chineselaw) for the benefit of the unitholders.
The relevant requirements are:(ii) Public funds: Article 32 of the Measures for the Administration of
the Operations of Publicly Offered Securities Investment Funds; and(iii) Insurance funds: Articles 2 to 4 of the Notice of the China
Insurance Regulatory Commission on Strengthening and Improving
the Proportional Regulation of the Utilization of Insurance Funds.
62

Articles 78 to 80 of the Code of Corporate Governance of Listed
Companies.

63

Article 13 of the Anti-Monopoly Law.

64

Article 15 of the Anti-Monopoly Law.

65

Article 15 of the Anti-Monopoly Law.

66

Article 20 of the Anti-Monopoly Law. Such collaborations can betreated as a concentration of undertakings where the Relevant
Investors acquire joint control or decisive influence over the invested
company by contract. “Control” or “decisive influence” is interpreted
broadly in China. Typically, control or decisive influence over acompany arises where the shareholder (or shareholders acting inconcert), directly or indirectly, owns more than half of the capital or
business assets, or has the power (including the de facto ability) toexercise more than half the voting rights, or has the power (including
the de facto ability) to appoint more than half the members of the
management or supervisory board, or has the right to decide thecompany’s strategic matters or manage the company’s business
operations. Negative control, ie the ability to block important
strategic decisions, is sufficient for control.

67

The Administrative Measures for the Disclosure of Informationof Listed Companies, the Measures for the Administration of the
Takeover of Listed Companies, listing rules of stock exchanges andrelevant implementation rules.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

68

Notice of the China Insurance Regulatory Commission on Mattersconcerning Further Strengthening the Regulation of Stock
Investments with Insurance Funds.

69

Articles 36, 44 and 51 of the Securities Law.

70

The Securities Law, the Measures for the Administration of the
Takeover of Listed Companies, listing rules of stock exchanges andrelevant implementation rules.

71

Under PRC law, government/public institutions and their employees
are required to appoint the central OAF management centre
established by the government or its local branches as their agent toestablish the OAF plan, collect fund assets, manage fund accounts,
and supervise the operation and risk control of the OAF, whose roleis similar to that of the fiduciary manager. The OAF agent has the
exclusive legal duty to appoint a qualified third-party entity (who isdeemed to be the trustee of OAF) to manage the assets of the OAF
pursuant to the OAF plan.

European Union

72

The Measures for the Administration of Insurance Clauses andPremium Rates of Personal Insurance Companies, and the
Guidelines on Developing Individual Tax-Deferred Commercial
Pension Products.

South Africa

73

The Notice of the China Insurance Regulatory Commission on Issues
concerning the Regulation of Personal Insurance Products with
Short and Medium Duration, and the Notice of the China Insurance
Regulatory Commission on Issues concerning Strengthening theAdministration of Products under the Reform of the Policy on
Personal Insurance Premium Rates.

United States

BrazilCanadaChina

FranceJapan

Netherlands

United Kingdom

GLOSSARY
REFERENCES(i) Pension funds: Article 37 of the Notice of the State Council on
Issuing the Measures for the Administration of Investment in Basic
Pension Insurance Funds, and Articles 28 and 29 of the Interim
Measures for the Investment Management of the National Social
Security Funds;

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CONTENTSFOREWORDSINTRODUCTION74

The key laws and regulations are:(i) BPF: the Notice of the State Council on Issuing the Measures for
the Administration of Investment in Basic Pension Insurance Funds;(ii) NSSF: the Regulation on the National Social Security Fund, andthe Interim Measures for the Investment Management of National
Social Security Funds;(iii) OAF: the Notice of the Ministry of Human Resources and Social
Security and the Ministry of Finance on Issuing the Interim Measures
for the Management of Occupational Annuity Funds;(iv) EAF: the Measures for the Management of Enterprise Annuity
Funds; and(v) insurance funds: the Notice of the China Insurance Regulatory
Commission on Issuing the Interim Administrative Measures for the
Entrusted Investment of Insurance Funds.

75

PRC law allows for the criminal liability of corporations only if
expressly provided in the Criminal Law.

76

There are specific crimes related to ESG issues For example, Section
6 of Chapter 6 of the Criminal Law prescribes a series of crimes inrespect of the protection of natural resources as a result of violating
relevant laws and regulations where the consequences are usually
severe.

77

Article 25 of the Criminal Law.

78

Articles 30 and 31 of the Criminal Law. Depending on specificcircumstances, criminal sanctions for individuals could be control,
detention or fixed-term/lifetime imprisonment plus fines, deprivationof political rights or confiscation of property.

79

http://www.gov.cn/gongbao/content/2015/content_2838171.htm

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

272

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EUROPEAN UNIONCONTENTSFOREWORDSINTRODUCTION

1.

INTRODUCTION

1.1

This annex considers the extent to which
Investing for Sustainability Impact (IFSI)
is required, or may be permitted, under
the laws of the EU as at 31 January 2021.
However, where sufficiently relevant,
we have also included more recent legal
developments. The EU is treated as a
‘jurisdiction’ for the purposes of thisreport; it is competent to adopt legallybinding rules within certain areas ofthe law, including the matters covered
herein.1 However, as regards legal rules
implementing EU law into nationallaw as well as practice, we refer to theannexes relating to the Member States, inparticular France and the Netherlands.

1.2

Terms defined in the report glossary apply
in this annex.

1.3This annex covers legislative and nonlegislative acts adopted by the bodies of
the EU or issued by EU authorities aswell as decisions by EU courts. Legislativeacts include:

ACKNOWLEDGEMENTS

1.5

1.6

• regulations, which have generalapplication, are binding in their entirety
and are directly applicable in all theMember States2; and• directives which are binding, as to theresult to be achieved, upon each Member
State, but leave the form and methodof implementation to their national
authorities.3 Directives have direct effectonly in exceptional circumstances.4
1.4

273

These legislative acts may delegate to theEuropean Commission the power to adopt
non-legislative acts to supplement or amend
specified parts of a regulation or directive.5
Delegated regulations and delegateddirectives have the same legal effects asregulations and directives, respectively.

1.7

EU legislation aims to harmonise therules among the different Member
States. However, in practice the system
is not perfect. The discretion inherent
in the need to implement directives anddiscretions granted to national authorities
under regulations can lead to differential
applications and interpretations among
the Member States. Only a decision of
the European Court of Justice (ECJ) gives
rise to a uniform interpretation of EU
legislation that is binding in all Member
States. However, decisions by the ECJ are
limited in number. The application andinterpretation of EU legislation may also
be guided by interpretations published by
EU authorities. This may assist, but does
not guarantee, consistent interpretation
or application.
This annex does not explore theimplementation or application of EU
legislation in particular Member States.
To the extent that rules are set out indirectives and therefore generally require
implementation, we have assumed thatthese rules have been implemented on a
‘copy out’ basis.
Further, the standards set by EU law which
we discuss below inevitably do not provide
a complete picture. For example, the legal
form of an institution for occupational
retirement provision (or IORP) or panEuropean personal pension product (orPEPP) is not specified in EU law. While the
Directive 2009/65/EC on the coordinationof laws, regulations and administrative
provisions relating to undertakings forcollective investment in transferable
securities (UCITS Directive)6 allows UCITS
to be constituted in accordance with
contract law (as common funds managed

by management companies), trust law(as unit trusts), or statute (as investmentcompanies), the actual legal forms in whicha UCITS can be established are governed
by Member State law (eg the corporate
law or trust law of the relevant Member
State). The Directive 2009/138/EC on thetaking and pursuit of the business of
Insurance and Reinsurance (Solvency II)7
refers to the permitted forms of insurance
undertaking under each Member State’s
legislation and the Directive 2014/65/EU on
markets in financial instruments (MiFIDII)8 generally requires that an investment
firm is a legal person constituted under
the law of a Member State. Accordingly,
the constitution of pension funds, mutual
funds authorised for distribution to retail,institutional investors and insurance
undertakings (collectively termed Asset
Owners) and the relevance of that
constitution to investment-related decisions
will be a matter of Member State law.
Similarly, as regards some forms of pension
provision, insurance policies and thearrangements between an Asset Owner andits investment manager, Member State lawsof contract will be relevant, and it is also
likely that Member State law will include
non-contractual tortious obligations thatare relevant to many of the relationships
between Asset Owners and beneficiaries
or between investment managers andAsset Owners (and possibly their own
beneficiaries). All these matters are outside
the scope of this annex. Therefore, there isvery limited discussion of market or goodpractice in this annex because this tends
to apply at Member State level and is only
sometimes reported in guidance or opinions
published by the ESAs.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

EUROPEAN UNIONCONTENTSFOREWORDSINTRODUCTION

1.8

The precise circumstances surrounding
each Asset Owner or investment
manager are critical to its investmentrelated decisions (ie those concerninginvestment, holding or disinvestment,
stewardship or public policy engagement- the expression is used in this annex
as a convenient shorthand to cover all
three). This annex seeks to summarise,at the level of EU law and subject to thevarious limitations described above, theframework of legal and regulatory issues
within which those decisions should bemade but is no substitute for legal advice
in individual circumstances.

EU action plan on sustainable finance

1.9

274

In recent years, the Commission has
communicated a strong political message
regarding the importance of sustainability
to the EU economy, including the financial
sector. The EU Action Plan on Sustainable
Finance9, which was published in March
2018, is a key part of the Commission’ssustainability initiatives and the most
relevant to this annex. It aims, among
other things, to reorient capital flows
towards sustainable investment in orderto achieve sustainable and inclusive
growth and has been the starting point
for many initiatives, including actions
designed to clarify institutional investors’
and investment managers’ duties inrelation to sustainability considerations.10
In December 2019, the Commission
presented a new growth strategy for
the EU that supports the transition of
the EU to a ‘fair and prosperous societythat responds to the challenges posedby climate change and environmental
degradation’, the so-called European
Green Deal11. In order to support the

EU’s ambitions for climate action and its
environmental policy underlined by theEuropean Green Deal, the EU consulted
on a renewed sustainable financestrategy between April and mid-July
2020,12 following which the Commission
published its comprehensive sustainablefinance package on 21 April 2021.13
1.10

to their clients.16 The same holds true
with regard to portfolio companies, whohave been subjected to more sophisticateddisclosure requirements recently.17
This trend is likely to continue andwill likely see disclosure requirements
becoming more and more demanding.18
This may cause relevant investors toafford sustainability aspects (whether
or not financially material) greater
weight in their investment activities.
As sustainability-related information
provided by their portfolio companies
will always be important in this context, abroader application of relevant disclosure
requirements to portfolio companies
should support this development.
While disclosure requirements do notin themselves modify the underlying
investment managers’ or asset owners’
duties with regard to the discretionary
management of clients’ assets, they may
create a tension between, if applicable,
legal obligations to prioritise financial
returns and disclosure requirements thatincentivise IFSI to enable relevant investors
to make more palatable disclosures.

The following two initiatives which form
part of the EU Action Plan on Sustainable
Finance represent key legislative
trends that drive the EU’s approach tosustainable financial markets.

Harmonised rules for assessing environmentally
sustainable economic activities
1.11

A cornerstone of the EU Action Planon Sustainable Finance is the adoptionof Regulation (EU) 2020/852 on theestablishment of a framework to facilitatesustainable investment (Taxonomy
Regulation)14. The taxonomy provided
by this regulation can be used for a
multitude of purposes. As things currently
stand, it will be primarily used as astandardised measurement framework to
avoid ‘greenwashing’ and to standardise
narrative disclosures to investors.
As part of the sustainable financepackage published on 21 April 2021,
the Commission also unveiled the EU
Taxonomy Climate Delegated Act,15 which
supplements the Taxonomy Regulation bydefining the technical screening criteria
for economic activities that can make a
substantial contribution to climate change
mitigation and climate change adaptation.

Increased regulatory focus on disclosure frameworks
1.12

Investment managers and Asset Owners
are increasingly expected to report on thesustainability aspects of their investment
activities beyond their financial materiality

1.13

In this context, the Regulation (EU)2019/2088 on sustainability-related
disclosures in the financial services sector(SFDR) establishes uniform, cross-sectoralrules for all relevant investors.19 It applies
as of 10 March 2021 and supplements
the disclosure requirements laid downin existing EU legislation. It seeks toestablish transparency not only regarding
the integration of sustainability risks
but also regarding the consideration of
relevant investor’s adverse sustainability
impacts, and the provision ofsustainability-related information withrespect to financial products.20 The SFDRACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

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uses the so-called ‘double materiality’
perspective which requires the integrationof material sustainability factors in
portfolios ‘with their impact on thefinancial position and future earning
capacity of a portfolio’s holdings (ie, the“outside-in” or “financial materiality”
perspective)’ but also ‘the impact of aportfolio on society and the environment(ie, the “inside-out” or “environmental/social materiality” perspective).”21
1.14

1.15

275

sustainable investment as their objective(Article 9 SFDR) and financial products
which merely promote, among othercharacteristics, environmental or social
characteristics, or a combination of thosecharacteristics (Article 8 SFDR).
1.16

To this end, a number of disclosure
obligations for relevant investors
are established, which relate to theinformation to be included on websites,in pre-contractual disclosures, inperiodic reports and in marketing
communications.22 Additional obligations
will apply in respect of financial productsthat promote environmental or social
characteristics or even have sustainable
investment23 as an objective.24
Regarding sustainability risks, definedas ‘environmental, social or governanceevent or condition that, if it occurs, could
cause an actual or a potential material
negative impact on the value of theinvestment’,25 Relevant investors willneed to provide information throughvarious channels on (a) their policies on
the integration of sustainability risks in
the investment decision-making process,(b) how their remuneration policies
are consistent with the integration ofsustainability risks and (c) the manner inwhich sustainability risks are integrated
into investment decisions and the resultsof the assessment of the likely impactsof sustainability risks on the returns of
the financial products made available.26
For example, the SFDR distinguishes
between financial products which have

1.17

In addition, relevant investors will haveto provide information on whether they
consider principal adverse impacts of theirinvestment decisions on sustainability
factors (defined as ‘environmental, socialand employee matters, respect for humanrights, anti-corruption and anti-bribery
matters’27) on their websites and, by
December 2022, at product level in precontractual disclosures.28 Where relevant
investors (voluntarily) consider suchadverse impacts, they will need to make astatement on their due diligence policies
with respect to these impacts.29 Otherwise,
they will need to give clear reasons why
these impacts are not currently considered
and whether changes are planned for the
future.30 From 30 June 2021, the SFDR
obliges certain large relevant investors
with more than 500 employees to publish
a statement on due diligence policies inplace with respect to principal adverse
impacts of investment decisions onsustainability factors.31 While the SFDR
explicitly relates only to disclosure, it
may well be argued that it also implies anobligation on the part of those required tomake the relevant disclosures to consider
and assess these potential impacts.
The SFDR aims to enhance transparency
with respect to the integration ofsustainability risks and factors in theirdecision-making process.32 Moreover,
Recital 12 SFDR explicitly sets forththat the ‘Regulation maintains therequirements for financial market

participants and financial advisers to act
in the best interest of end investors’,33
implying that it does not materiallyaffect the investment manager’s duties
vis-à-vis its investors. On the other hand,
Recital 18 SFDR sets out that financial
market participants should integrate
in their processes sustainability factors
and risks only ‘[w]here financial market
participants, taking due account of theirsize, the nature and scale of their activities
and the types of financial products they
make available, consider principal adverse
impacts’. This reference to the size offinancial market participants as a reason
for taking into account principal adverse
impacts strongly indicates that large
relevant investors must take into accountthe principal adverse impact of theirinvestment decisions on sustainability
factors. This view is further bolstered byseveral pieces of legislation included in
the sustainable finance package publishedon 21 April 2021 that seek to align theexisting legal duties for some relevant
investors with the SFDR.34

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

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1.18

The (first) sustainable finance package
which was published by the Commission
on 21 April 2021 aims to improve the flowof capital towards sustainable activities
across the EU.35 The measures aredesigned to enable investors to re-orient
investments towards more sustainable
technologies and businesses and support
the goal to make Europe climate neutral
by 2050. The sustainable finance package
is comprised of:• the EU Taxonomy Climate Delegated

Act which supplements the Taxonomy
Regulation and aims to support
sustainable investment by making
it clearer which economic activities
contribute to meeting the EU’s
environmental objectives;• a proposal for a Corporate Sustainability

Reporting Directive (or CSRD) which aims
to improve the flow of sustainability
information by portfolio companies; and• six amending delegated acts on existing

legal duties, investment and insurance
advice which aim to ensure that financial
firms, eg advisers, asset managers or
insurers, include sustainability in theirprocedures and their investment advice
to clients.

1.19

On 6 July 2021, the Commission adopted
a further package of measures aimed
at improving the financing of thetransition to a sustainable economy.36
This package includes, amongst others,
the delegated act supplementing
Article 8 of the Taxonomy Regulation.37
Article 8 of the Taxonomy Regulation
obliges certain large undertakings todisclose information on how and to what
extent their activities are associatedwith economic activities that qualify asenvironmentally sustainable under theTaxonomy Regulation. The delegated
act supplementing Article 8 of theTaxonomy Regulation sets out thecontent, methodology and presentationof information to be disclosed by large
financial and non-financial companies
and is further specified by several
annexes.38 The delegated act is intended
to increase transparency in the market
and prevent ‘greenwashing’.39

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

276

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2.

ASSET OWNERS’ USE OF POWERS OF INVESTMENT AND DIVESTMENT

2.1

This section considers the extent to which
and in what circumstances, each type ofAsset Owner is required or permitted to use
its powers of investment and divestment toinvest for sustainability impact.

2.1.1

2.1.2

277

Generally, there is legislation outside thescope of the rules we discuss below thatis designed to enhance environmental orsocial sustainability, and which has theeffect of limiting the freedom of each of
the Asset Owners to use its investment
powers. For example, anti-money
laundering legislation (which aligns
with SDG 16.4) is designed to prevent
terrorist and criminal activities since they
are inconsistent with social wellbeing40
and the EU sanctions regimes can becharacterised in the same way41.
To summarise briefly what we explainin more detail in the sections below, an
Asset Owner would, if it considered one
or more sustainability factors posed amaterial risk to its ability to meet its
financial investment objective over the
relevant timeframe, be legally obliged toconsider what steps it can take to mitigatethat risk. If it identifies reasonable
steps it can take to bring about specificsustainability impact goals related tosustainability factors, then we see a
duty to act accordingly in the interest ofachieving the financial return objective(instrumental IFSI). In addition, Asset
Owners may also pursue sustainability
investment objectives alongside financial
objectives, unless it may affect thefinancial performance of an investment
negatively (ultimate ends IFSI). As noted
above, this annex does not address
relevant aspects of Member State law
which may also impact on the answer tothese questions in particular cases, andthere are a number of issues in practicethat are not the subject matter of thisreport such as assessing the impact steps
of investors actually have on the relevant
sustainability goals.42
2.2

Pension funds

2.2.1

Types of pension funds covered43

pension market. The PEPP Regulation will
start to apply on 22 March 2022.47
2.2.4• Asset Owner: for IORPs, the occupational

pension fund. For PEPP providers, thepersonal pension fund.48• Beneficiaries: for IORPs, beneficiaries are

Institutions for occupational retirement provision
2.2.2

The main entities/groups of persons
involved are:employees and, where permitted by therelevant Member State (see 2.2.1 above),self-employed persons which are, in eachcase, in the position of a ‘beneficiary’ (iea person receiving retirement benefits)
or a ‘member”’ (ie a person entitled
to retirement benefits).49 Additionally,
employers might be considered as a further
group of beneficiaries due to their position
as contracting party of the employees,
which will depend on Member State law.
For PEPP providers, consumers who are a
PEPP saver (ie a person who has concluded
a PEPP contract with a PEPP provider) ora PEPP beneficiary (ie a person receiving
PEPP benefits) qualify as beneficiaries.50

This annex considers institutions foroccupational retirement provision (orIORPs) which are, in particular, regulated
by Directive (EU) 2016/2341 on theactivities and supervision of institutions
for occupational retirement provision(IORP II)44. IORPs are institutions,irrespective of their legal form, thatmanage collective retirement schemes for
employers, in order to provide benefits
for employees and, where permitted
by Member State law, to self-employedpersons.45 IORPs in one Member State canmanage occupational pension schemes forcompanies established in another Member
State and, as a result, pan-EU companies
can have a single pension fund for all
their subsidiaries throughout the EU.

• Investment decision-maker: For IORPs,

the occupational pension fund. For PEPP
providers, the personal pension fund.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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Providers of pan-European personal pension productOverview

Netherlands

2.2.3

2.2.5

South Africa

This annex also considers PEPP providers.
These are financial undertakings authorised
to manufacture and distribute a panEuropean personal pension product (orPEPP). A PEPP is a voluntary personal pension
scheme that complements an existing public
or occupational pension system, or a national
private pension scheme. PEPPs are mainly
regulated by the Regulation (EU) 2019/1238
on a pan-European Personal Pension Product(PEPP Regulation)46, which establishes a legal
foundation for a pan-European personal

The investment duties of IORPs and
PEPP providers are determined by (i) the
respective contractual terms of the relevant
pension scheme or PEPP; (ii) EU legislation(as detailed below); and (iii) the nationallaw of the respective Member State(including the constitutional documents
and related law applicable to the specificlegal form of the IORP or PEPP provider).
As noted in section 1 above, we have notcovered national laws in this annex.

United Kingdom
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2.2.6

At the EU law level, the main investmentrelated duties and powers of insurers areprimarily set out:

decision-making where these effects arefinancially material as well as where they
are not necessarily relevant to the IORP’s
investment goal.

• with respect to IORPs by IORP II; and• with respect to PEPP providers by the

PEPP Regulation.
IORPs
2.2.7

Under EU legislation, certain key
investment duties and powers of IORPs are
set out, in particular, by IORP II. Broadly,
the main legal duties and powers under
EU legislation are:(a) Prudent person principle and the best (financial)long-term interest of beneficiaries. IORPs are
required to invest in accordance with
the PPP.51 This requires, in particular,that assets are invested in the best longterm interest of beneficiaries as a whole.
The primary aim of IORPs is to ensure
financial security and good pensions
for the beneficiaries in retirement.52
Therefore, in general, the beneficiaries’‘best long-term interest’ is served where
the IORP’s portfolio achieves risk-adjusted
financial return consistent with the IORP’s
investment goal. In the case of a conflictof interest, IORP II explicitly requiresthat investment-related decisions must be
made in the sole interest of beneficiaries.53
Nevertheless, within the PPP, ‘Member
States shall allow IORPs to take into
account the potential long-term impact ofinvestment decisions on environmental,social, and governance factors’.54 IORP II
specifically uses the word ‘impact’ withrespect to ESG factors,55 which are notnecessarily related to any financial return.
Consequently, this provision implies that
IORPs may consider the long-term effects
of investment decisions on sustainability
factors in their investment-related278(b) Characteristics of the portfolio. The
investment of the assets shall ensure thesecurity, quality, liquidity and profitabilityof the portfolio as a whole as well as aproper diversification.
(c) Governance. Member states must require
IORPs to have in place an effective systemof governance proportionate to the size,
nature and complexity of the activitiesof the IORP. Such a system shall include
consideration of ESG factors related toinvestment assets in investment decisions.56(d) Risk management and risk assessment.
IORPs must maintain an effective riskmanagement system, which shall be
proportionate to their size, internalorganisation and activities and which shallcover, among other things, the areas ofinvestment, liquidity and concentration
risk management as well as ESG risks
relating to the investment portfolio and the
management thereof.57 Further, IORPs are
required to carry out and document theirown-risk assessment.58 Where ESG factors
are considered in investment decisions,
IORP II expressly determines that the risk
assessment needs to include an assessmentof new or emerging risks, including risks
related to climate change, use of resources
and the environment, social risks and risks
related to the depreciation of assets due toregulatory change.59
PEPP providers
2.2.8

The PEPP Regulation sets out certain key
investment duties and powers of PEPP
providers. Broadly, the main legal duties
and powers under the PEPP Regulation are
as follows.

(a) Prudent person principle and the best
(financial) long-term interest of beneficiaries.
A PEPP provider shall invest its PEPPrelated assets in accordance with the
PPP.60 This requires, in particular, aninvestment in the best long-term interestsof beneficiaries as a whole. The PEPP
Regulation explicitly specifies that, in thecase of a potential conflict of interest,
the investment must be made in the soleinterest of beneficiaries.
However, as part of the PPP, PEPP
providers shall take into account ‘risks
related to and the potential long-term
impact of investment decisions on ESG
factors’.61 Under the PEPP Regulation, ‘ESG
factors’ are defined as ‘environmental,social and governance matters such as
those referred to in the Paris Agreement,
the United Nations Sustainable
Development Goals, the United Nations
Guiding Principles on Business andHuman Rights and the United Nationssupported Principles for Responsible
Investment’.62 Although this definitionis rather broad, it clarifies that ESG
factors must be taken into account whenassessing financial performance.
(b) Characteristics of the portfolio. The
investment of the assets shall ensure thesecurity, quality, liquidity and profitabilityof the portfolio as a whole as well as aproper diversification.63(c) Risk mitigation. The use of risk-mitigation
techniques shall ensure that theinvestment strategy for the PEPP is
designed to build up a stable and adequate
individual future retirement income fromthe PEPP and to ensure a fair treatment of
all generations of beneficiaries.64

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

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United Kingdom
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Legal requirement to use investment powers to invest
for sustainability impact
IORPs
2.2.9

Under IORP II, IORPs are, as a generalprinciple, not explicitly obliged touse investment powers to invest forsustainability impact.

2.2.10 As noted at section 2.2.6(a) above, IORPs
must be allowed by the Member States toconsider the potential long-term impact ofinvestment decisions on ESG factors.65 This
does, however, not strictly oblige themto consider ESG factors66 or sustainability
impact in their investment decisions,nor does it require them to invest forsustainability impact.
2.2.11 However, it cannot be excluded that there
may be certain situations in which IORPs
are required to consider sustainability
factors, and to act accordingly. This
would in particular be the case where
sustainability factors have an impact
on financial return goals and, in thesecircumstances (instrumental IFSI could
be in their chosen response), as briefly
described below.
2.2.12 Financial materiality. There may becertain situations which give rise to a
duty to take account of sustainability
impact. This might be the case where
IFSI corresponds to the ‘best interest’of beneficiaries, ie where sustainability
factors are to be considered financiallymaterial. Sustainability factors may befinancial risks and be therefore financiallymaterial regarding the performance of aportfolio. For example, sustainability risks
may materialise as market, operational,
litigation or reputational risks.67
2.2.13 As indicated by several public surveys,68
the public awareness in respect of279

sustainability impact is increasing.
Moreover, the increased focus onsustainability issues in the legal andregulatory framework, for example
the SFDR and EIOPA’s opinion on the
supervision of the management ofenvironmental, social and governancerisks faced by IORPs,69 might intensify
the general necessity for pension funds tohave regard to sustainability risks. EIOPA
states that the competent authorities
should, among other things, ‘review
whether IORPs have adequately integrated
ESG risks in their risk management
system’.70 Moreover, EIOPA points outthat taking into account ESG factors ‘toreduce the exposure of IORPs toward
ESG risks is likely to help IORPs in the
pursuit of sustainability goals. Conversely,
considering the long-term impact ofinvestment decisions on ESG factors cancontribute to mitigating IORPs’ exposures
to ESG risks.’71
2.2.14 Where sustainability risks materialise as
financially relevant risks, it can be argued
that it is ‘prudent’ in the traditional sense
to take such risks into account as part of
the PPP. The question whether certain
sustainability risks could be qualified as
financially material depends on the time
period over which potentially relevantrisks are assessed. In relation to thetypical time horizon relevant for pension
funds, please refer to section 8.3.1 et seq.
2.2.15 Furthermore, one might suggest thatpension funds, which operate with longterm horizons, might, as part of acting in
the beneficiaries’ ‘best interest’, be obliged
to secure future financial interests ofbeneficiaries by taking sustainability risks
into account even where they could not
be classified as ‘financially material’ froma current perspective. One might argue
that pursuant to the PPP, investments
need to be aligned with the ‘best long-term
interests of members and beneficiaries asa whole’.72 Recital 7 IORP II also indicates
that, as a general principle, IORPs should,
where relevant, take into account theobjective of ensuring the intergenerationalbalance of occupational pension schemes.73
The current wording of IORP II, however,leaves substantial doubt whether and, towhat extent, risks could be qualified aspart of the PPP where they cannot (yet)be considered as ‘financially material’,especially if such consideration would
negatively affect the financial return.
2.2.16 Where long-term risks are systemic,
such duty might also be disproportionate
considering the practical difficulties
an individual investor would face inaddressing them: collaboration withother investors may be necessary insteadof single actions by individual investors.
Collective action is likely to increasea positive sustainability outcome andreduce the costs related to IFSI for
individual investors. What the duties ofpension funds may require with regard
to collective action with other investors,
will depend on the circumstances of
the individual case. Such collaboration
will need to comply with applicablelegal requirements such as competition
legislation or rules on insider dealing andmarket abuse (see discussion of collective
action in Part B).
2.2.17 Additionally, there might be arguments(discussed briefly below) to interpretthe duty to act in the beneficiaries’‘best interest’ as a duty to exercise
investment powers for sustainability
impact as a standalone (ultimate ends

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

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IFSI). EU legislation does not, however,generally provide for a duty to invest forsustainability impact.
2.2.18 Non-financial factors. It is not made clear
in IORPII whether the ‘best interest’ ofbeneficiaries is limited to financial interest
or can also include non-financial factors.
One could argue that the beneficiaries’‘best interest’ is able to comprise nonfinancial aspects such as the well-being or
health of beneficiaries. On this basis, one
could suggest that pension funds may be
obliged to pursue non-financial objectives
relevant for beneficiaries also in cases
where their (future) financial interests
are not affected. However, according to its
purpose, the PPP serves as an investment
rule for IORPs whose main aim is (froma traditional perspective) to provide
their respective beneficiaries with aretirement income. This suggests that thebeneficiaries’ ‘best interest’ is primarily
met where the investment secures their(future) pension entitlements. For thesame reason, it is unclear whether IORPs
could, under certain circumstances,
be required to seek to ensure wider
societal objectives. This indicates that
any investment for sustainability impact
would need to comply with the limits of
the PPP, ie it must not negatively affectthe financial return of an investment.
2.2.19 Beneficiaries’ preferences. Under current
EU law, the predominance of thebeneficiaries’ ‘best interest’ as a rule fortaking investment decisions may not bechanged solely by potential sustainability
preferences of an IORP’s beneficiary. IORP
II, however, allows for the consideration of
the impact of investment decisions on ESG
factors as part of the PPP. Therefore, IORPs

280

may also be entitled, although not obliged,
to consider their beneficiaries’ views on
ESG factors.74
PEPP providers
2.2.20 The PEPP Regulation does generally notprovide for an obligation of PEPP providers
to use their investment powers to invest
for sustainability impact. Therefore, theposition described for IORPs is similar for
PEPP providers (see section 2.2.9 et seq.).
2.2.21 This means that, in particular, IFSI in
the form of instrumental IFSI – ie where
the pursuing of a sustainability objective
ultimately serves the financial goal –would be covered by the requirement of
the PPP under the PEPP Regulation.
2.2.22 Unlike IORP II, the PEPP Regulation
determines that PEPP providers shall takeaccount of risks related to and the potential
long-term impact of investment decisions
on ESG factors.75 However, the obligation
to take account of certain factors primarily
constitutes a procedural requirementand does not override the basic financial
investment goal of the PEPP. The duty totake account of the potential long-term
impact of investment decisions on ESG
factors does not therefore generally oblige
PEPP providers to pursue(ultimate ends
IFSI). Examining this in more detail, under
Article 41(1) (b) PEPP Regulation, PEPP
providers are required to take into accountrisks related to and the potential longterm impact of investment decisions on
ESG factors. In contrast, Article 41(1) (a)PEPP Regulation explicitly requires that
assets shall be invested in the best longterm interest of beneficiaries. Similarly,
Article 41(1) (c) PEPP Regulation sets outthat assets shall be invested in such a manneras to ensure the security, quality, liquidity
and profitability of the portfolio as a whole.
Thus, the wording of Article 41(1) PEPP
Regulation differentiates between the(procedural) duty to ‘take into account’certain factors and the duty to ‘invest’ ina specific manner. Additionally, according
to the wording of Article 41(1) (b) PEPP
Regulation, the duty to ‘take into account’risks related to ESG factors applies within the
PPP. This suggests that this duty does notoverride the obligation of PEPP providers toinvest in the ‘best interests’ of beneficiaries.
2.2.23 Additionally, the PPP does in principle
not require PEPP providers to assess theviews of beneficiaries on whether theywish to pursue IFSI. PEPP providers are
required to specify the ‘retirement-related
demands and needs’ of the prospective
beneficiary and to provide a PEPP contract
which is consistent with the beneficiary’s
demands and needs.76 Moreover, certain
PEPP providers are required to assess thesuitability of a PEPP for the respective
customer, among other things, byobtaining information on that person’s
investment objectives.77 Non-financial
objectives are not explicitly addressedbut could be considered to fall within thewording of Article 34 PEPP Regulation.
Thus, the assessment of the suitability ofa PEPP may generally cover sustainability
impact as a category as well, and suchobjectives may thus be pursued in parallel
to a financial return objective provided
that they do not negatively affect thefinancial return. However, there is no
explicit legal requirement to do so.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

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Legal freedom to use investment powers to invest forsustainability impact
IORPs
2.2.24 This question only arises where there
is not already a duty to invest forsustainability impact, ie where thesustainability factors under consideration
are not financially material. We consider
that the duties of IORPs pursuant to
IORP II are flexible enough to allow for
IFSI as long as certain conditions aremet; Member State laws, which are notdealt with in this annex, might, however,impose more restrictive conditions..
2.2.25 IORP II explicitly prescribes that IORPs
should be allowed to consider the potential
long-term impact of investment decisions
on ESG factors as part of the PPP.78
2.2.26 However, this freedom is subject to the PPP
as underlying principle (see section 2.2.6(a)and 2.2.11 et seq.). Therefore, the integrationof sustainability impact in investment
decisions must not conflict with thebeneficiaries’ ‘best long-term interest’; inparticular, it should not negatively affectthe investment’s risk-adjusted financial
return and endanger the beneficiaries’(future) pension entitlements. Wherea conflict arises between sustainability
impact and financial return, theinvestment would rather need to be madein favour of the (financial) ‘best interest’ of
the beneficiaries.
2.2.27 As long as the PPP is preserved, IORPs
should, in principle, be free to use
their investment powers79 to invest forsustainability impact. Pursuant to theCommission, there is a ‘growing consensus’,that the ‘consideration of ESG factors iscompatible with fiduciary duties when:281• the ESG factors have a financial material

impact on the investment performanceor valuation;• it is reasonable to assume that taking

into account ESG factors is supported
unanimously by the beneficiaries; and• ESG factors are a distinctive element whencomparing investments with otherwise
similar characteristics”.80
2.2.28 With regard to the first two points, pleaserefer to Section 2.2.10 and Section 2.2.18.
The third point listed by the Commission
suggests that IFSI should typically bepossible under the PPP where it does notnegatively affect the financial return
but acts as a distinctive element among
several equivalent investment options.
2.2.29 Further, IORP II allows in its Article
19(1) (b) for the consideration of the
impact of investment decisions on ESG
factors as part of the PPP. This implies
that IORPs should also be entitled toconsider their beneficiaries’ views
on sustainability factors or risks.81
Furthermore, the consideration of ESG
factors is, pursuant to the wordingof Article 19(1) (b) IORP II, part of theapplication of the PPP and needs therefore
to be in line with its limits. In practice it
might, however, be difficult to ascertain
sufficiently the prevailing views of thebeneficiaries and members ‘as a whole’.82
Typically, beneficiaries are likely to havedifferent views on sustainability factors.
Additionally, appropriate procedures
would need to be established to assess thebeneficiaries’ preferences.
2.2.30 The obligation to pursue the ‘best interest’of beneficiaries does not expressly specify
whether IORPs are also obliged to seek
the maximum rate of risk-oriented

financial return. On the one hand, thismight be implied by the requirement topursue the ‘best’ interest consideringthat IORPs primarily aim at ensuring
good pensions for their beneficiaries.
Moreover, Article 19(1) (c) IORP II (andsimilarly Article 41(1) (c) PEPP Regulation)requires investments to be made to seek
profitability of the portfolio. On the other
hand, the obligation to seek profitability
does not prescribe a particular level ofreturn which should be achieved. The
typical duration of the liabilities ofpensions funds implies a general longterm character of their investments.83
However, some of IORPs investments may
also be short term, to match short-term
payment obligations.84 Thus, the principleof maximising financial return requires
a balancing of interests of members andbeneficiaries fairly to cover short-, middleand long-term perspectives.
2.2.31 Moreover, IORP II85 implies that the ‘best
interest’ of the beneficiaries must not
be assessed in relation to the individual
investment but rather with regard to the‘portfolio as a whole’. This might allow forsome freedom in the specific shaping of theinvestments as long as the ‘best’ financial
return of the portfolio as a whole (taking
account of risk) is not negatively affected.
2.2.32 It cannot be excluded that pension funds
might, under certain circumstances, bereluctant to make use of their investment
freedom in favour of IFSI, for instance,
due to legal uncertainties which exist
with regard to the interpretation of
the beneficiaries’ ‘best interest’ and its
interaction with IFSI (see section 2.2.24
et seq.). This might, from time to time, be
perceived as increased liability risk.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

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2.2.33 Nevertheless, there seems to be someindication that the PPP under IORP II‘has not proven to be a barrier towards
sustainable investments’.86 Moreover,in its advice on potential undue shortterm pressure from financial markets on
corporates, EIOPA concluded that there ‘isno clear evidence of behaviors that could
be labelled as undue short-termism’ in
IORPs, neither is there any ‘clear evidenceof undue short-term pressures fromfinancial markets’ on IORPs.87

2.3.3

2.3.4

PEPP providers
2.2.34 Similar to IORPs, the regulation of PEPP
providers should, in our view, be flexible
enough to invest for sustainability impact
as long as certain conditions are met.
2.2.35 Under the PEPP Regulation, PEPP providers
shall take into account risks related toand the potential long-term impact ofinvestment decisions on ESG factors within
the PPP. This does, however, not oblige a
PEPP provider to pursue ultimate ends IFSI
but leaves the possibility open to choosesuch option within the framework of the
PPP. Thus, the position of PEPP providers
regarding their legal freedom to invest forsustainability impact is, in essence, similar
to that of IORPs. Please refer, therefore, tosection 2.2.23 et seq.
2.3

2.3.5

Mutual funds

Types of mutual funds covered
2.3.1

2.3.2

282

EU law provides for a framework ofprovisions applicable to mutual funds (andtheir managers) which are establishedand supervised in Member States. Again
Member State law may also impact thequestion addressed below.
This annex only covers undertakingsfor collective investment in transferable

2.3.6

securities (UCITS) which are typicallytargeted at retail investors.88• Beneficiaries: the investors who hold

The UCITS Directive89 describes UCITS as
undertakings for collective investments
which solely invest in transferable
securities or other liquid financial assets
and whose units can be repurchased orredeemed at the unit-holder’s request outof the assets it holds.90• Investment decision-maker: the UCITS

UCITS can either be constituted inaccordance with contract law (ascommon funds managed by managementcompanies), trust law (as unit trusts) or
statute (as investment companies).91 A
UCITS can either appoint an external
UCITS management company or,
where it has legal personality, beinternally managed.92 However, theregulatory obligations with regard to the
management of the UCITS’ assets are notaffected by the choice of structure.

management company or any external
Investment Manager to which the portfolio
management function has been delegated
2.3.7

2.3.8

It follows that for UCITS the key parties are:legal form)93

It is important to note that the UCITS
Directive addresses both UCITS and their
management companies and even allows
that both roles are combined in one
person. It follows that, where this annex
refers to UCITS or mutual funds as theholders of powers or as being subject toobligations, such reference shall equally
include the management company.

Overview

In this annex, irrespective of the legal
form a UCITS may take (contractual, trust
or company form), we always consider
the UCITS itself (whether or not it has
separate legal personality) as the Asset
Owner. However, it is legally permitted
and common in practice that managementcompanies delegate the portfolio
management function to external asset
managers. Management companies mustmonitor and supervise the compliance ofinvestment managers with this regulationin order to remain compliant themselvesbecause delegation does not release themfrom their responsibilities. For that reason,
UCITS management are also considered as
investment managers in this annex.
• Asset Owner: UCITS (irrespective of its

ACKNOWLEDGEMENTS

shares or units in the UCITS

2.3.9

The management company’s duties
and powers are governed by the UCITS’constitutional documents, particularly
the investment objectives and policies, aswell as EU legislation, in particular the
UCITS Directive and its supplementing
delegated directives and regulations.
However, within the UCITS framework,
the UCITS Directive does not prescribe
many of the UCITS mechanics such as thedetermination of a specific investment
policy or how an investment policy ischanged. These aspects of mutual funds
are governed by Member State law.
Accordingly, this annex does not take
into account specific constraints which
follow from an existing investment
policy the change of which may require
investors’ (unanimous) consent. In fact,
this may pose significant obstacles tothe introduction of mutual funds for the
purpose of ultimate ends IFSI, but this is
not a result of EU legislation.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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management company is, amongst
others, required:(a) to act honestly and fairly in conducting its
business activities in the best interest of
the UCITS it manages and the integrity ofthe market; and(b) to act with due skill, care and diligence, inthe best interests of the UCITS it manages
and the integrity of the market.94
2.3.10 The duty to act in the ‘best interest’is set out in more detail in the UCITS
Delegated Directive, including rules
on due diligence, inducements andthe best execution of orders.95 The
UCITS Delegated Directive specifies,
among other things, the organisational
requirements, conflicts of interest,
conduct of business and risk management
rules for management companies.
2.3.11 The UCITS Delegated Directive specifies
the ‘best interest’ rule by requiring,
among other things, that the unit-holdersof managed UCITS are treated fairly by
the management company and thatmanagement companies shall refrainfrom placing the interests of any groupof unit-holders above the interests of any
other group of unit-holders.96 Mutual
funds are most commonly established
for the purpose of generating financial
return. The ‘best interest’ of UCITS istherefore served where the financial
return is maximised in line with theinvestment objectives of the UCITS.97 In
addition, UCITS management companies
are required to use fair, correct andtransparent pricing models and valuation
systems for the UCITS they manage. They
are also required to act in such a way as toprevent undue costs being charged to the
UCITS and its unit-holders.98
283

2.3.12 When taking investment decisions, UCITS
management companies must ensure ahigh level of diligence in the selection andongoing monitoring of investments, inthe best interests of UCITS.99 This includes
adequate knowledge and understandingof the assets in which the UCITS are
invested.100 To ensure that investment
decisions are carried out in compliance with
the UCITS’ objectives, investment strategy
and risk limits, UCITS managementcompanies must establish written policies
and procedures on due diligence andimplement effective arrangements.101
Legal requirement to use investment powers to invest
for sustainability impact
2.3.13 EU legislation does currently not provide
for rules which require a UCITS to take
into account non-financial objectives, suchas ultimate ends IFSI as a part of their due
diligence process (as a ‘procedural rule’)or as part of their investment decisions(as a ‘substantive rule’). Therefore, UCITS
and/or their management companies are
not subject to an explicit general duty
to invest for sustainability impact as astandalone duty (ultimate ends IFSI).
2.3.14 However, UCITS and/or their managementcompanies will be required to take into
account the sustainability impact ofinvestments under specific circumstances
when taking investment decisions.
2.3.15 A duty to invest for sustainability impact
may arise in individual cases where it is inthe ‘best interest’ of the UCITS to do so, ie
an obligation to pursue instrumental IFSI.
The Commission noted that ‘EU legislation
does not constitute a barrier to integrate
ESG factors. While ESG factors are notexplicitly mentioned in the relevant
EU legislation […] existing financial

regulation provides scope to incorporate
them, given that all factors that have amaterial impact on financial performance
should be considered in the investment
and advisory process’.102 As the ‘best
interest’ is most commonly pursued by
maximising financial return, the question
whether sustainability impact must be
pursued as a parallel objective (ultimate
ends IFSI) will need to be answered
depending on whether financial returnand sustainability impact are aligned, in
conflict with each other or compatible.
2.3.16 The impact on financial return andsustainability impact may be aligned, forinstance, by investing into a company
whose activities have a beneficial effecton the environment that is directly linked
to an increased financial return (eg sincethe ‘green’ activities are also enhancing
the company’s competitive position on themarket). Likewise, any risks (including thoseconnected to sustainability) which may havea negative impact on the financial return of
the UCITS also need to be reflected in therisk management of the UCITS.103
2.3.17 Any potential conflict between IFSI andfinancial return would have to be resolved
by an interpretation of the ‘best interest’of the UCITS. There are no statutory rules
on how to resolve a conflict between
maximising financial return and IFSI.
Thus, where it is clear that financial
return is the UCITS’ main objective,
such conflict would generally have to beresolved in favour of financial return sothat no duty to invest for sustainability
impact arises (unless the two are aligned(see 2.3.16.).104 Typically, if the UCITS is
tailored to pursue IFSI, we would expect
the investment policy to address the issueof how a conflict (i) between sustainability

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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impact and investment return; and (ii)between different elements of IFSI can be
resolved. Even a conflict between different
elements of IFSI may occur, for instance,
when an investee company’s activities
may be beneficial for the workforce(and, thus, socially beneficial) but have anegative impact on the environment.
2.3.18 If IFSI neither aligned with or in conflictwith financial return, UCITS are currently
not obliged to choose the more sustainable
investment. According to the Commission,
there is a ‘growing consensus’, that the’consideration of ESG factors is compatible
with fiduciary duties if: the ESG factors
have a financial material impact on theinvestment performance or valuation;
it is reasonable to assume that taking
into account ESG factors is supported
unanimously by the beneficiaries, or ESG
factors are a distinctive element whencomparing investments with otherwise
similar characteristics’.105 According to
the reports that substantiate the ‘growing
consensus’, where ESG factors are thedistinctive element, these factors may betaken into account but there is no obligation
to do so.106 In other words, there is no
obligation to invest for sustainability impact
even in a ‘tie-break scenario’ although there
is a discretion to do so. Note, however thismay change (see 2.3.29. below).
2.3.19 In practice, it is unlikely that taking ESG
factors into account will be supported
unanimously by the beneficiaries, unlesssuch views are set forth the investment
policy of the UCITS. Nor is there arequirement to ask for the actual unitholders’ views since determining the ‘best
interest’ of a UCITS does not require an
assessment of the actual beneficiaries’
views. Accordingly, there is also no284

requirement to invest for sustainability
impact even if the (current) unit-holders’views uniformly support IFSI (unless thisis explicitly permitted by the investment
policy of the fund).
2.3.20 Acknowledging that the ‘best interest’ ofunit-holders is determined primarily byfinancial return raises additional questions,such as whether this requires balancing
their financial return with the financial
return of future unit-holders, which may
be negatively affected by a decision infavour of short-term profit at the expenseof sustainability impact. The requirementof equal treatment of unit-holders under
the UCITS Delegated Directive107 indicates,
however, that it is not permitted (andtherefore also not required) to place theinterests of future unit-holders over theinterests of current unit-holders. For thesame reason, it is also neither permitted
nor required to take diverging sustainability
aspirations of fund investors into accountwhere they are not explicitly mentioned in
the investment policy of the fund.
2.3.21 The basic circumstance that the ‘best
interest’ of unit-holders is complied withby securing or maximising financial returnin line with the investment policy forthem, leaves open the question whether
this requires the optimisation of return(in relation to the risk that the UCITS is
permitted to take) or the securing of acertain level of financial return beyond
which a UCITS may also decide to pursue
secondary objectives (such as IFSI) andto sacrifice a certain amount of profit toachieve that secondary objective. In ourview, the ‘best interest’ currently requires
optimising financial return, while it leaves
the question unanswered over which time
period the financial return needs to beachieved. This is crucial since decisions infavour of sustainability impact involves
seeking to secure long-term profits at theexpense of short-term gains (or the incurringof immediate costs). There is no fixed
time period in EU legislation over which
the financial return needs to be achieved.
Acting in the ’best interest’ of unit-holders
should require determining the typicalinvestment horizon for the individual UCITS.
Since UCITS are open-ended and therefore
subject to constantly changing ownership,
investment horizons may typically berather short-term, whereas also long-term
strategies may well be pursued making useof the UCITS framework.
2.3.22 The circumstances under which a UCITS
may be legally required to seek to secure
wider societal objectives (ultimate ends
IFSI) are rare. The UCITS Directive requires
UCITS to also act in the best interest of
the integrity of the market.108 However,acting in the ‘integrity of the market’ does
not generally justify IFSI. As the UCITS
Delegated Directive states, it rather aims
to capture ‘preventing malpractices thatmight reasonably be expected to affect thestability and integrity of the market’109(eg where a ‘fire-sale’ may limit losses of
the UCITS but would lead to significant
price volatility) but rather not to generally
balance goals such as pursuing financial
return and ultimate ends IFSI.
Upcoming changes in regulation
2.3.23 The Commission has published the final
UCITS ESG Delegated Directive that will
amend the UCITS Delegated Directive.110
The main aim of the UCITS ESG DelegatedDirective is to ensure consistency
between the disclosure requirements of
the SFDR, as described in more detail in
section 1.13 et seq., and organisational

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

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requirements under the UCITS DelegatedDirective.111 The UCITS ESG DelegatedDirective establishes rules that prescribe
under which circumstances and for what
purpose a UCITS must take into accountsustainability-related considerations.
2.3.24 Among other things, UCITS managementcompanies will explicitly be required
to take into account sustainability
risks when complying with the due
diligence requirements.112 Sustainability
risks can have a potential impact onfinancial return113 and already need to beconsidered so the potential amendment isonly for clarification purposes.114
2.3.25 In addition, the UCITS ESG DelegatedDirective provides that ‘wheremanagement companies […], consider
principal adverse impacts of investment
decisions on sustainability factors as
described in […], or as required by […],
those management companies […] take
into account such principal adverse
impacts when complying with the [duediligence] requirements’.115 Sustainability
factors are not necessarily linked tofinancial return.116
2.3.26 The UCITS ESG Delegated Directive
does not aim to amend the generalprinciple of ‘best interest’. ESMA has
explicitly refused to amend the generalprinciple of ‘best interest’ since ESMA is
not persuaded that this would ‘provide
more benefits compared to making therequested legislative clarifications directlyin the due diligence requirements’. Thisappears generally convincing in relation tosustainability risks. Where ‘sustainability
risks’ have a negative impact on the valueof the investment, they already need tobe taken into account in order to comply
with the principle of ‘best interest’ for285

that reason anyway.117 So no amendmentof the ‘best interest’ principle is needed.
2.3.27 On the other hand, it is for various reasons
uncertain whether, and to what extent,
the UCITS ESG Delegated Directive will
impact the ‘best interest’ determination of
UCITS and establish to a duty to (or at least
increase flexibility for) IFSI as standalone
objective (ultimate ends IFSI).
2.3.28 Assuming the SFDR requires, at least,
UCITS management companies toconsider the principal adverse impactof their investment decisions onsustainability factors, it is unclear which
purpose is to be pursued based on thoseconsiderations.118 The provision may beinterpreted to only require considerationin the due diligence process or also to
become a decisive factor for the selectionof the investments (which would result ina duty to invest for sustainability impact).
Taking into account the relationship with
the SFDR, it may be concluded that only
a procedural requirement is stipulated,
and that the requirement is only designed
to require management companies todisclose the principal adverse impactof their investment decisions.119 On theother hand, sustainability factors aretaken into account when complying withthe requirements of Article 23(1) to (4)UCITS Delegated Directive, which includes
the obligation to ensure a high level ofdiligence in the selection and ongoing
monitoring of investments. This is anindication that they may be intended toinfluence the investment decision.
2.3.29 Further, assuming that the investment
decision is influenced by the principal
adverse impact on sustainability factors,
and therefore an obligation to invest
for sustainability impact will arise, it isuncertain how such obligation interacts
with the ‘best interest’ of the unitholders, under which circumstances
and to which extent the sustainability
impact may or must be pursued, even
if to do so negatively affects financial
return. While such an obligation may,in general, provide UCITS managementcompanies with a justification to invest
for sustainability impact, it is far fromclear what the boundaries of such duty
(and legal flexibility) are. Managementcompanies may therefore be reluctant
to incorporate sustainability impact
on a broad basis into their investment
decision-making processes. However, in a‘tie-break scenario’, UCITS would arguably
be subject to an obligation to invest forsustainability impact.
Legal freedom to use investment powers to invest forsustainability impact
2.3.30 As set out in section 2.3.11 the ‘best
interest’ of a UCITS is served where afinancial return consistent with theinvestment objectives of the UCITS isachieved so that IFSI may generally be
only pursued where it is aligned with
their objective, ie to generate financial
return (instrumental IFSI). Various
other legal provisions may further limit
the possibility of UCITS managementcompanies and investment companies toinvest for sustainability impact.
2.3.31 For instance, management companies
must act in a way as to prevent undue
costs being charged to UCITS and its unitholders.120 Costs associated with pursuinginvestment strategies that take the impact
of investment decisions on sustainability
factors into account may be considered asundue costs if the investment policy does
not permit this.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
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2.3.32 Management companies must haveadequate knowledge and understandingof the assets in which the UCITS are
invested.121 A lack of relevant knowledge
and difficulties in obtaining the relevant
data on IFSI sustainability factors will inpractice hamper its integration.122
2.3.33 Management companies must use fair,correct and transparent pricing models
and valuation systems for the UCITS they
manage.123 This requirement is subject
to national law and is also subject tonational authorities’ interpretation.
However, to the extent that sustainability
impact does not relate to financial risk
and return, it seems to be accompanied byenhanced difficulties to comply with therequirement of fair and correct pricing
models since there are no clear rules on
how this requirement applies to IFSI.

liability is to pay on a valid claim by thepolicyholder. Any profits of investment
activity are retained by the insurer.
2.4.2• Beneficiaries: Beneficiaries of the insurance

undertaking are any natural or legal
persons who are entitled to benefit under aninsurance contract, including policyholders
and insured persons. The shareholders of an
insurance company form a further categoryof an insurer’s beneficiaries because of theireconomic interest in the management of an
insurance company’s assets.
• Investment decision-maker:

Insurance company.
Overview

2.3.34 Disclosure obligations – while themselves
not requiring IFSI – might ‘nudge’ mutual
funds towards considering ultimate ends
IFSI since (potential) beneficiaries may beinterested in it.124
2.4

Insurance undertakings

Types of insurance undertaking covered
2.4.1

We consider in this analysis:• life insurance undertakings - theseprovide assurance, in consideration forthe payment of a premium, on death oranother defined event by payment of alump sum or fixed regular income. Life
insurance, in principle, also includes
annuities on a contractual basis; and• general insurance undertakings which

underwrite policies that are not life
insurance, including, among other things,
sickness, fire and natural forces, property
and liability insurance. The general insurer’s

286

The key parties are:
• Asset Owner: Insurance company

2.4.3

2.4.4

within Solvency II130 and EIOPA’s technicaladvice on the integration of sustainability
risks and factors in the delegated acts
under Solvency II and IDD.131

The investment-related duties of insurance
undertakings are typically determined by(i) EU legislation, (ii) the national law of
the relevant Member State (in particular
in relation to directors’ duties of care)and (iii) in the case of a life insurer, theterms of the contract concluded with therelevant policyholder which again will be
subject to the laws of a Member State.
At the EU law level, the maininvestment-related duties and powers of
insurers are primarily set out by:• Solvency II;• Directive (EU) 2016/97

125(IDD);• PRIIPs Regulation126;• Solvency II Delegated Regulation127;• Amendment Solvency II DelegatedRegulation;128 and• Amendment IDD Delegated Regulation129

in conjunction with guidance issued by
EIOPA such as the opinion on sustainability

2.4.5

Generally, the key investment duties of
insurers arising out of EU law can besummarised as follows:(a) Prudent person principle. Member
States have to ensure that insurance
undertakings invest in accordance with
the PPP.132 This means, in particular, thatwith respect to the whole portfolio ofassets, the insurer is required to invest
in assets ‘whose risks the undertaking
concerned can properly identify, measure,monitor, manage, control and report,
and appropriately take into account in
the assessment of its overall solvency
needs’.133 Further, the PPP requires that
all assets of the insurer are invested insuch a manner ‘as to ensure the security,
quality, liquidity and profitability of theportfolio as a whole’.134 Additionally, asregards assets which are held to cover
the technical provisions, these are to
be invested ‘in the best interest of allpolicyholders and beneficiaries taking into
account any disclosed policy objective’.135
In particular, the requirement to ensure
the ‘liquidity’ and ‘profitability’ of theportfolio indicates that the main objectiveof the PPP under Solvency II is to ensure
financial return, which needs to beconsistent with the respective policy
objective and to have appropriate regard
to the risks involved.
In the case of a conflict of interest, Solvency
II explicitly provides that the investment
has to be made in the best interest ofpolicyholders and insured persons.136

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B. THE EXTENT TO WHICH
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Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

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Moreover, insurers have to observe
diversification duties and restrictions on
assets which are not admitted to trading
on a regulated financial market.137(b) The integration of sustainability risks in
the implementation of the PPP has beenclarified by the Amendment Solvency II
Delegated Regulation, which has been
adopted by the Commission on 21 April
2021. The Amendment Solvency II
Delegated Regulation provides for the
inclusion of a new article on the PPP in
the Solvency II Delegated Regulation
stating that when ‘identifying, measuring,monitoring, managing, controlling,
reporting and assessing risks arisingfrom investments, as referred to in thefirst subparagraph of 132(2) of Directive
2009/138/EC, insurance and reinsurance
undertakings shall take into accountsustainability risks’. Additionally, it isclarified that for ‘the purpose of paragraph
1, insurance and reinsurance undertakings
shall take into account the potential longterm impact of their investment strategy
and decisions on sustainability factors and,
where relevant, that strategy and thosedecisions of an insurance undertaking
shall reflect the sustainability preferencesof its customers taken into account in
the product approval process as referred
to in Article 4 of Commission DelegatedRegulation (EU) 2017/2358’.138(c) Risk management and risk management
function. Based on the Amendment
Solvency II Delegated Regulation,
insurance undertakings will be required toconsider sustainability risks in their risk
management. Further, the identification
and assessment of sustainability risks
will be included in the tasks of insurance
undertakings’ risk management287

function.139 The Amendment Solvency II
Delegated Regulation thereby clarifies thatsustainability factors may be financiallymaterial and need to be considered in linewith other relevant risks.

advice on IBIPs.145 This introduces anadditional element into the suitability
assessment, so that an insurer selling
an IBIP will be required to, among
other things, assess the suitability of a
product for the customer by obtaining
such information as is necessary to
determine their personal recommendation
to the (potential) customer meets his/
her investment objectives, ‘includingthat person’s risk tolerance and any
sustainability preferences’.146(d) Actuarial function. The Amendment
Solvency II Delegated Regulation provides
that insurance undertakings’ actuarial
function will have to take into accountsustainability risks in its assessment of theuncertainty involved in estimates made in
the calculation of technical provisions.140(e) Calculation of ‘best estimate’. Furthermore,when calculating the ‘best estimate’,insurers are obliged to take into
account expected future developments,
including, among other things, social andenvironmental developments, that will
have a material impact on the cash in- andout-flows required to settle the insurance
obligations over the lifetime thereof.141
According to Article 77 Solvency II, the ‘best
estimate’ is relevant for the calculation of
the value of technical provisions.
(f) Insurance distribution. In case an insurancecompany also carries out insurance
distribution, the insurance undertaking
is obliged to act ‘honestly, fairly andprofessionally with the best interestsof their customers’.142 Further, it has
to ensure that any contract proposed isconsistent with the customer’s insurance
demands and needs.143
Moreover, the Amendment IDD DelegatedRegulation adopted by the Commission
on 21 April 2021, amends Commission
Delegated Regulation (EU) 2017/2359,144
among other things, by introducing therequirement for insurance undertakings
to assess sustainability preferences of their(potential) customers when providing

Legal requirement to use investment powers to invest
for sustainability impact

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

General insurer
2.4.6

2.4.7

2.4.8

Under current EU law, non-life insurers
are not subject to an explicit generalobligation to use investment powers toinvest for sustainability impact.
Article 132 Solvency II sets the PPP as
the overarching investment rule (seesection 2.4.5(a)).147 The investment
principles provided under Solvency II
do not specifically address sustainability
risks.148 However, this does not mean thatgeneral insurers would not be obliged
to take into account sustainability risks
in their investment decisions and to act
accordingly. This has now been clarified by
the adoption of the Amendment Solvency
II Delegated Regulation.
Financial materiality. Generally, it canbe suggested that there is a duty totake account of sustainability risks
and to act accordingly in line with the
PPP where such risks are relevant tothe ‘best interest’ of beneficiaries (seesection 2.4.5(a)). This would be the casefor instrumental IFSI as well as ultimate
ends IFSI provided that pursuing thesustainability objective has no negative

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impact on the financial return objective.
Sustainability risks will often materialise
as financial risks in the traditional
sense.149 For instance, it is generally
recognised that climate change-relatedrisks may manifest as transition risks
which can be caused by the (regulatory or
technological) adjustment process aiming
at a low carbon economy; alternatively,
they may manifest as physical risks inthe shape of extreme weather events orlonger-term climate changes such as risingtemperatures.150 Climate change-relatedrisks may also lead to an increase inliability risks, for example where physicalrisks such as floods or storms cause
property losses.151 Transition, physical or
liability risks may, in turn, affect insurers,
for example, as market risk, counterparty
default or underwriting risks.152 EIOPA
noted therefore that it ‘has become clear,over the past years, that sustainability
risks and in particular climate-changerisks will affect insurance and reinsurance
undertakings’.153 Generally, such risks canbecome material for insurance companies
in two ways:• They can affect the assets in which an

insurer invests (eg in the shape ofmarket risks) and thus materialise as
investment risks.154• Sustainability risks may specificallyaffect the underwriting risk (eg in case ofproperty or natural forces insurance).155
2.4.9

288

In both cases, it may be ‘prudent’ ordue for an insurer to take such risks
into account.156 However, the question
whether a sustainability risk is financiallymaterial depends on the time period andover which potentially relevant risks areassessed. In relation to the typical time
horizon relevant for insurers, please referto section 8.3.6.
2.4.10 Amendment Solvency II Delegated Regulation.
By adopting the Amendment Solvency II
Delegated Regulation, the Commission
clarified157 that sustainability risks must be
taken into account in the implementationof the PPP. For this purpose, ‘sustainability
risks’ are defined as environmental, social
or governance events or conditions that,
if they occur, could cause an actual or
potential negative impact on the value of theinvestment or on the value of the liability.158
2.4.11 Insurers will not only need to assesssustainability risks in relation to theirinvestment the investment portfolios but
will also be required to take into accountthe potential long-term impact of theirinvestment decisions on sustainability
factors.159 As pointed out by EIOPA, thisrequirement to take into account the
impact of the investment on sustainability
factors ‘would not amount to requiringundertakings to make sustainable
investments or to invest with impact, orto accept lower risk-adjusted returns’,160
ie it would not establish a duty to pursue
ultimate ends IFSI. However, according
to EIOPA, this requirement may include‘undertakings’ active engagement withinvestees to achieve sustainable investment
outcomes through voting strategies orother investment strategies’.161
2.4.12 Furthermore, insurers must reflect intheir investment process the sustainability
preferences of their customers as taken
into account in the product approval
process.162 Thus, the Amendment Solvency
II Delegated Regulation opens up a pathway
for insurers to pursue sustainability
impact goals where such goals are inline with customers’ sustainability
preferences (ultimate ends IFSI). Thisrequirement applies ‘where relevant’ andthereby establishes a link between the
manufacturing of insurance products
and the investment decision process.163 As
pointed out by EIOPA, ‘ESG preferences
should be reflected in the investments
where ESG preferences are expressed aspart of product oversight and governance’164
and also see to section 5.4.9 et seq.
2.4.13 Conflict of interest. In relation to cases ofa potential conflict of interest, Solvency
II explicitly sets out that the investment
must be made in the best interest ofpolicyholders. Thus, the predominant factor
which the investment has to be alignedwith is the interest of the beneficiaries toensure the due fulfilment of their valid
claims. Therefore, where a conflict arises
between sustainability impact and financial
return, the investment would need tobe made in favour of the (financial) ‘best
interest’ of the beneficiaries. However,insurers would be allowed to pursue
sustainability goals where customers haveexpressly chosen a sustainability impact
goal or where such goals do not negatively
affect the financial return of the investment(ultimate ends IFSI).
2.4.14 Beneficiaries’ views. The PPP does not
generally require insurers to assess
the views of beneficiaries on whether
they wish to pursue IFSI.165 Similarly,
there is generally no obligation to alignthe investment with the sustainability
preferences of beneficiaries.
Life insurance
2.4.15 For the reasons set out in section 2.4.7 etseq., we do not consider that life insurers
are subject to a general obligation touse investment powers to invest forsustainability impact although there
may be certain situations in which

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B. THE EXTENT TO WHICH
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such a duty may arise. Life insurers are
however generally obliged to consider
sustainability risks and to act accordingly
where such risks are financially material
and therefore in line with the ‘best
interest’ of beneficiaries.

case. As a general rule, the greater the
impact of certain systemic risks on thefinancial return, the more likely it is thatsuch obligation to cooperate with otherinvestors to achieve sustainability impact
goals might arise (instrumental IFSI).168

2.4.16 In contrast to general insurers, life
insurers typically need to cover a longer
time horizon within their investment
decisions for their assets held to cover
the technical provisions. This may imply
that long-term sustainability risks are
generally of greater relevance for life
insurers than for general insurers. Thus,
Article 132(2) subparagraph 3 Solvency
II provides that with regard to assets
held to cover the technical provisions,insurers are obliged to invest in amanner appropriate to the nature andduration of the insurance liabilities.
EIOPA therefore takes the view that for‘(longer-term) life business, the longhorizon for cash-flows also means that
there may be room to consider the impact
of climate change in the calculation of
the best estimate’.166 Further, EIOPA has
pointed out that where ‘undertakings
have long-term assets to match long-term
liabilities they should consider whether
climate change would impact either theirability to hold these assets over that timeframe or their expected cash-flows’.167
In order to effectively address long-term
systemic risks, relevant investors would
generally need to collaborate with otherinvestors. Collective action is likely toincrease a positive sustainability outcome
and reduce the costs related to IFSI for
individual investors. What the duties of
insurers may require regarding collective
action with other investors, will dependon the circumstances of the individual

2.4.17 Under the Amendment IDD DelegatedRegulation, insurers will be required toassess sustainability preferences of their(potential) customers when providing
advice on IBIPs.

289

Legal freedom to use investment powers to invest forsustainability impact
General insurer
2.4.18 Under current EU law, general insurers
are free to use investment powers toinvest for sustainability impact as longas certain conditions are observed where
they are not subject to a duty to invest forsustainability impact due to the financial
materiality of certain sustainability factors(instrumental IFSI).
2.4.19 As explicitly clarified by the Amendment
Solvency II Delegated Regulation, the PPP
requires insurers to take into accountsustainability risks. This implies that
insurers may, in principle, be allowed toinvest for sustainability impact on theultimate ends basis IFSI provided thatthe investment decision is compatible
with the PPP as overarching investment
principle (see section 2.4.5(a) and 2.4.7 etseq.). The PPP requires, in particular, thatthe integration of sustainability factors
in investment decisions does not conflictwith the ‘best interest’ of policyholders.
Such a conflict might arise where an
investment decision would affect theinsurers profitability and liquidity in a
way that could endanger its ability to duly
meet its policyholders’ valid claims.

2.4.20 Further limits to an insurer’s freedom
to integrate sustainability factors in its
investment policy might arise out of its
director’s duties. National corporate law
may require a company’s directors to act
with reasonable care and diligence (see,for instance, with respect to the position
under Dutch or French law the Dutch andFrench annexes). Generally, if such duty ofcare exists under national corporate law,
it might allow for the consideration of
long-term or sustainability factors which
could affect the company as a whole when
taking entrepreneurial decisions. However,it will ultimately depend on the specificconditions of the situation (including the
purpose of the company) as well as on thelaw of the relevant Member State whether
and to what extent such considerations
will be possible. For instance, where a
director’s duty of care explicitly permits
or recommends the inclusion of longterm consequences or sustainability
factors, there should be more flexibility tointegrate ESG or sustainability factors in
the investment process.
2.4.21 As part of the PPP under Solvency II,
insurance companies are obliged to invest
in a manner as to ensure the liquidity
and profitability of the portfolio as awhole. This requirement does, however,not include the prescription of a specificfinancial return to be achieved. Moreover,the liquidity and profitability of theportfolio need to be balanced with its
security. The objective to ensure thesecurity of a portfolio generally requires
a proper assessment of the relevant risks
involved with an investment, including
sustainability risks.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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2.4.22 Furthermore, Solvency II implies thatthe investment objectives ‘security’,Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

EUROPEAN UNIONCONTENTSFOREWORDSINTRODUCTION‘quality’, ‘liquidity’ and ‘profitability’ do
not refer to the individual investment
but to the portfolio as a whole.169 As
is clarified by the explanatory text to
Guideline 29 on the System of Governanceby EIOPA, undertakings may therefore‘have individual investments that do
not fulfil every feature even if they will
finally contribute to the security, quality,
liquidity and profitability of the portfolio
as a whole’.170 Further, pursuant to this
explanatory text, in ‘order for thesequalitative features to provide a realbenchmark against which compliancecan be assessed, it needs to be specified
to what extent individual investments
do not necessarily have to meet all thesequalitative features’, concluding that
assets that do not fulfil every qualitative
feature ‘must be kept at prudent levels’.171
This provides some flexibility in theshaping of specific investments.
2.4.23 Regarding the legal framework as
applicable prior to the adoption of theAmendment Solvency II DelegatedRegulation, EIOPA has come to theconclusion that it ‘did not receive any
evidence that the current design andcalibration of the Solvency II frameworkprovides either an incentive to invest
in sustainable assets or a disincentivethat hinders investments in sustainableassets’.172 This suggests that although
the PPP as such does not promote IFSI, it
allows insurers to pursue sustainability
impact goals. The clarifications adopted
by the Amendment Solvency II DelegatedRegulation may well facilitate theintegration of sustainability risks andfactors into the framework of the PPP.

290

Life insurance
2.4.24 For the reasons set out in section 2.4.19 etseq., life insurers are allowed to invest forsustainability impact subject to the termsof the relevant policy and provided thatcertain conditions are complied with.
2.4.25 Regarding life insurers, the assessment ofthe ‘best interest’ of beneficiaries within
the PPP might typically be considered more
complex than under a general insurance.
On the one hand, the ’best interest’ oflife insurance policyholders requires, inparticular, that the future financial returnis secured for the duration of the policy.
On the other hand, as has been set out by
EIOPA, for ‘(longer-term) life business, thelong horizon for cash-flows also means that
there may be room to consider the impact
of climate change in the calculation of thebest estimate’.173 This may imply that for life
insurers, there is more leeway to consider
sustainability risks and factors and tointegrate these in their investment decisions.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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3.

ASSET OWNERS’ USE OF POWERS OF STEWARDSHIP

3.1

The following section considers theextent to which, and on what basis,each type of Asset Owner is required or
permitted to use its position to influence
the activities of investee enterprises byengaging in stewardship activities witha view to influencing portfolio company
behaviour as part of a strategy to invest
for sustainability impact.

one of the levers that can help improve thefinancial and non-financial performanceof companies, including as regards
environmental, social and governancefactors, in particular as referred to in the
Principles for Responsible Investment,
supported by the United Nations’.181 In the
EU Action Plan for Sustainable Finance, theCommission underlines that investments
for environmental and social objectives
require a long-term orientation and thatsustainability and long-termism therefore
go hand in hand.182 ESMA found that longterm engagement is increasingly widespreadamong investors183 but recommended
further monitoring of whether theapplication of SRD II is effective toencourage long-term engagement.184

Overarching considerations
3.1.1

3.1.2

291

The main pieces of EU legislation thatcover stewardship activities for some,
but not all, Asset Owners are theShareholders’ Rights Directive (SRD)174
which relates to the exercise of certain
shareholder rights attaching to voting
shares in relation to general meetings ofcompanies whose shares are admitted to
trading on a regulated market in the EU
and have their registered seat in a Member
State175 and the Shareholders’ Rights
Directive II (SRD II)176, which applies toall Asset Owners that are covered by
the SRD. The SRD II seeks to strengthen
stewardship and to address short-termism
and principal-agent problems in theinvestment chain. In particular, the SRD II
can be seen as establishing stewardshipduties for ‘institutional investors’177 to theextent that they invest directly or throughan asset manager in shares traded on aregulated market, and ‘asset managers’178
to the extent that they invest in suchshares on behalf of investors.179
The SRD II acknowledges that asset
managers play a significant role in thecorporate governance and the strategy
and long-term performance of portfolio
companies.180 In particular, the SRD II
points out that: ‘greater involvement ofshareholders in corporate governance is

3.1.3

3.1.4

A recent study prepared for theCommission that assessed the root
causes of ‘short-termism’ in corporate
governance further found that shorttermism is partially linked to pressure
from institutional investors.185 However,the study also found other causes for
short-termism that are outside the scopeof this annex such as the definition andinterpretation of directors’ duties and‘company’s interest’ and that the longterm interests of stakeholders other thanshareholders are not sufficiently taken
into account by board members.186
Pursuant to the SRD II, an Asset Ownermust develop and publicly disclose apolicy that describes how it integrates
stewardship in its investment strategy
or publicly disclose a clear and reasoned
explanation why it has chosen not todevelop a policy.187 An stewardship policy
contains the following elements:

ACKNOWLEDGEMENTS(a) monitoring of the investee companies on
relevant matters, including socialand environmental impact andcorporate governance;188(b) conducting dialogues withinvestee companies;(c) the exercise of voting rights;(d) cooperation with other shareholders;(e) communication with relevant stakeholdersof the investee companies; and(f) managing actual and potential conflicts ofinterests in relation to their stewardship.
Alternatively, an Asset Owner is required
to publicly disclose publicly a clear andreasoned explanation why it has chosen
not to comply with the requirement todevelop and disclose stewardship policy.189
3.1.5

3.1.6

However, even if an Asset Owner bound bythese requirements decides to exercise its
powers of stewardship, these rules are notexplicitly designed to deliver sustainability
impact as such instead of, or in addition
to, their contribution to investment
return. They nevertheless leave someleeway for an Asset Owner.190
Certain duties and obligations of Asset
Owners under EU law could make it
more difficult to engage in stewardship
activities in relation to portfolio
constituents by reference to theirsustainability impact as a standalone
objective (ultimate ends IFSI) than it isto pursue an instrumental IFSI strategy,
although these duties (below) are relevantin all cases.

(a) Cost. Engagement in stewardship activities
involves cost. An Asset Owner (and its
investment manager) would need tobe satisfied that incurring that cost is

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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consistent with its duties under EU law. In
many cases, stewardship activities for the
benefit of sustainability impact will haveno (or just minimal) effect on the financial
return of the individual investment. For
instance, in relation to UCITS, these costs
could be considered as ‘undue costs’ andnot be in the ‘best interest’ of the UCITS,
especially where they are in pursuit ofan objective other than the UCITS’ statedinvestment objective.
(b) Competition law. Co-ordination between
investors designed to wield collective‘shareholder’ influence over the ESG
strategy of a company in which they
are invested is likely to fall outside therealm of competition law, assuming nocompetitively sensitive information isshared between investors. Co-operation
between Asset Owners and/or investment
managers beyond this is possible, butneeds to be structured in a way thatcomplies with competition law since there
is no specific exemption to competition
law for arrangements designed to address
sustainability risks. Collaboration between
competitors amounting to price fixing,
collective boycotts, or the sharing ofmarkets and customers will virtually
never be permitted.191 A collaborative
arrangement involving the exchange
of information or the coordination ofcommercial activities may also infringe
competition law if it is anticompetitivein object or effect and is not otherwise
exempt. In most competition law
regimes, including that of the EU,
exempt arrangements must be necessary
and proportionate in order to provide
an improvement to the production or
distribution process, or a promotion oftechnical or economic progress, whileallowing consumers a fair share of the292

resulting benefits, and still allowing
for sufficient residual competition in
the market.192 Parties are required toprovide quantitative evidence of such
improvements and consumer benefits ifthey wish to rely on such an exemption.
(c) The Commission recognises theimportance of sustainability on current
and future domestic and global agendas
and has consulted on how competition
law can support the EU Green New Deal.193
However, it has yet to release further
guidance and while there is some caselaw, there are not enough past examples
to give certainty around what evidence ofsustainability benefits will be enough tojustify competitor collaboration in practice.
Collaborative arrangements enteredinto for sustainability impact may notnecessarily provide direct improvements
and/or consumer benefits that outweightheir anticompetitive harm, or to theextent that they do, these benefits may bedifficult to measure and prove in monetary
terms.194 In addition, even encouragement
by regulators or government bodies forcollaborative action will not necessarily
shield from competition law scrutiny,195
or from private competition actions
brought by companies whose businesses
are impacted by collaboration between
Asset Owners and/or investment managers
with a view to improved sustainability
outcomes. Additional guidance isrequired from competition authorities(here, the EC) to explain in more detailtheir attitude to investor collaboration
to address sustainability risks and how
sustainability outcomes can be quantified
and assessed within the existing horizontal
collaboration regime.

(d) Nonetheless, there remain a wide range ofcollaborative actions that relevant investors
may take. These include, for example:(i)collaboration towards non-binding
and non-individualised sustainability
targets (especially where parties areafforded a high level of discretion as
to the means by which they attainsuch an objective);196(ii) joint initiatives to develop standard
investment classification ormeasurement tools (provided there
are fair, non-discriminatory and equal
rights to their use);(iii) exchanging information and bestpractice insights on IFSI
(provided the information is notcompetition sensitive);(iv) joint initiatives to enable the rise of
new markets and services;197 and(v)

joint advocacy/dialogue with
policymakers and stakeholders. Most
recently, competition regulators arealso increasingly open to discussing
sustainability initiatives and arestarting to recognise the need forfurther and more harmonised
guidance. There are a number ofconsultations ongoing that are
expected to clarify and, to somedegree, soften, the past enforcement
climate and provide a better
framework to account for wider
societal benefits.198(e) Though operating within the margins
of competition authority guidance may
not prevent private competition actions
being taken against Asset Owners and/or
investment managers who act collectively,
it does lower the risk of such actions
being brought successfully since a court

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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would assess whether the collaboration
was in line with competition law and thatjurisdiction’s relevant guidance.
(f) There may also be other (actual or
perceived) circumstances that may makeit difficult for an Asset Owner to engage in
stewardship activities, such as the rules on
insider trading and market manipulation199,
or the legal uncertainty around thequestion of which level of coordination
results in concerted action and, thus, toadditional obligations under the rules on
notifications on major holdings200 or the EU
legislation covering takeovers for entities
traded on regulated markets.201
3.2

the financial return over the relevanttime horizon is affected by certain
sustainability risks.
Legal freedom to steward for IFSI
3.2.4

For the reasons set out in section 2.2.23 etseq. and section 2.2.33 et seq., pension funds
are free to engage (in ultimate ends IFSI) as
long as certain conditions are observed.

3.2.5

Under IORP II and the PEPP Regulation,pension funds are obliged to comply with
the PPP (in relation to the PPP, see section
2.2.5(a) and 2.2.11 et seq.). The PPP allows
for a certain degree of flexibility in shaping
the investment policy. Moreover, since SRD/SRD II explicitly impose certain stewardship
activities on IORPs, this indicates thatstewardship activities can generally becompliant with the duties of pension funds.

Pension funds

Legal requirement to steward for IFSI
3.2.1

3.2.2

3.2.3

293

For the reasons set out in section 2.2.9
et seq. and section 2.2.19 et seq., neither
IORPs nor PEPP providers are subject to a
general duty to use stewardship to pursue
an invest for sustainability impact.
Although there are disclosure duties inrelation to stewardship for IORPs202(see3.1.1. above) , these do not include a
specific obligation to seek improvement in
the investment’s sustainability impact of
portfolio companies (see section 3.1.5).
Furthermore, there are no explicit
indications under sector-specific EU law
that pension funds are generally required
to cooperate with other investors to
mitigate sustainability risks arising out
of systemic challenges. Such cooperation
may however enhance the effectivenessof an engagement for sustainability
impact. What the duties of pension
funds may require regarding collective
action with other investors will dependon the circumstances of the individual
case, in particular on the extent to which

3.2.6

3.2.7

3.3

A pension fund’s stewardship forsustainability impact should not, however,
get in conflict with the beneficiaries’‘best long-term interest’. This requires,in particular, that any stewardship forsustainability impact does not endanger
the due fulfilment of the (future) pension
entitlements of the beneficiaries.
Moreover, engagement for sustainability
impact may involve costs. This might
impede stewardship insofar as pension funds
would need to ensure that the costs incurred
would be compatible with their legal duties.
Nevertheless, the ‘comply or explain’
provisions concerning stewardship activities
under the SRD/SRD II (see 3.1.4. above)might, where applicable, encourage IFSI.
Mutual funds

Legal requirement to steward for IFSI
3.3.1

Under EU law, management companies
must develop adequate and effective
strategies for determining when and how
voting rights attached to instruments

held in the managed portfolios are to be
exercised, to the exclusive benefit of the
UCITS concerned.203
3.3.2

3.3.3

There is no legal provision in EU law or
guidance by EU regulatory authorities
that considers this requirement inrespect of IFSI or other sustainability
matters. The provision does, however,
not amount to a legal requirement tosteward for sustainability impact. For
instance, the Committee of European
Securities Regulators (CESR), indicatedthat the ‘exclusive benefit’ may also becomplied with by not exercising voting
rights at all if a passive investment
policy is followed.204 Although it is notentirely clear whether this statement
can be applied more generally so thatmanagement companies can freely decide
to not exercise voting rights at all, it
appears that there is some flexibility andtherefore no general duty to exercise
voting rights to pursue IFSI or engage byother means.205
There is, in particular, some legal
uncertainty around whether ‘exclusive
benefit’ needs to be interpreted similarto ‘best interest’ when conducting
investment activities, which is primarily
by reference to financial return. Pursuingfinancial return by exercising voting
rights may therefore amount to an
obligation where financial return andsustainability impact are aligned (as is
the case with instrumental IFSI). An
argument for a broader understanding of‘exclusive benefit’ can be made from theperspective of investment theory. Modern
portfolio theory, which has significant
impact on investment activities of UCITS
in practice and which is concerned withthe optimisation of risk and return,

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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applies only to portfolio construction
but not to stewardship. On the other
hand, there is no reason to assume
that a strategy in the ‘best interest’ of
UCITS should not be to their ‘exclusive
benefit’. Accordingly, the terms should beinterpreted in a similar manner.
3.3.4

294

The financial return of portfolio
companies may not only be impacted byfactors that apply to individual portfolio
companies included in the portfolio but
also by sustainability factors that impact
across the portfolio (or even the market– egsystematic risks). One may argue
that there is a duty to consider engaging
and, under specific circumstances,to act accordingly in such cases (andinstrumental IFSI is a strategy designed
to do this). This can in practice, be
carried out by addressing the issues at
an individual company level, but also
by cooperating with other companies
and their shareholders whose activity
makes a difference. Over the long-term,
this may result in an increased financial
return. That approach may, however, facepractical difficulties, namely that there
will often be only a long-term gain at
the expense of a short-term loss, which
could be considered an ‘undue’ cost.
UCITS management companies that apply
modern portfolio theory strictly may behesitant to engage in this way since it isa basic tenet of modern portfolio theory
that systematic risks cannot be mitigatedby investors (bearing in mind, however,that modern portfolio theory does notdirectly apply to stewardship activities).

Legal freedom to steward for IFSI

Legal freedom to steward for IFSI

3.3.5

General insurance

3.4

This question only arises where there
is not already a duty to invest forsustainability impact, ie where thesustainability factors under consideration
are not financially material. Against
the backdrop that, generally, UCITS
management companies must conduct
their business activities in the bestinterests of the UCITS they manage andthat undue costs should be prevented,
there is arguably limited flexibility toengage for sustainability impact as aseparate objective (ie ultimate ends IFSI).
Under the current EU framework, UCITS
may therefore be reluctant to engage for
ultimate ends IFSI.
Insurance undertakings

Legal requirement to steward for IFSI
General insurance
3.4.1

For the reasons outlined in section
2.4.7 et seq., non-life insurers are notgenerally subject to a duty to steward forsustainability impact.

Life insurance
3.4.2

3.4.3

As with general insurers, life insurers
are not subject to a general duty to use
stewardship to invest for sustainability
impact for the reasons set out in section
2.4.15 et seq. Life insurers may however
be required to consider and to act
accordingly if sustainability risks have an
impact on the financial performance of aninvestment goal (instrumental IFSI).
Further, similarly to IORPs, life insurers
may be subject to the stewardship-related
disclosure duties as set out by SRD/SRD II(see section 3.2.2) which may encouragethem to consider IFSI strategies.

3.4.4

3.4.5

For the reasons set out in section 2.4.18
et seq., general insurers are allowed to
steward for sustainability impact on an
ultimate ends basis. Provided that certain
conditions are observed. General insurers
may however be required to consider,and to act accordingly, if sustainability
risks have an impact on the financial
performance of an investment goal
(instrumental IFSI).
Sector-specific EU law does not regulate
the stewardship activities of generalinsurers. However, it does not prohibit
them either. This suggests that an
investor’s engagement activities may
in principle be compatible with its
investment duties. However, a generalinsurer’s engagement for sustainability
impact must not conflict with theapplicable internal investment policies
or legal duties. Thus, a general insurer
would, in particular, need to ensure thatits engagement does not negatively affectthe investment’s financial return andthereby interfere with the beneficiaries’‘best interest’. Further, the costs
associated with stewardship activities
might impede stewardship insofar as
insurers would need to make sure that thecosts incurred would be compatible with
their legal duties.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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Life insurance
3.4.6

3.4.7

For the reasons set out in section 2.4.24 etseq., life insurers are allowed to engage forsustainability impact on an ultimate ends
basis provided that certain requirements
are observed.
Sector-specific EU law does not expressly
prohibit life insurers from stewarding
for sustainability impact. Additionally,
it provides for certain stewardshipduties and rights of life insurers under
the framework of SRD/SRD II. Although
SRD/SRD II does not explicitly set out
a life insurer’s duty or right to engage
specifically for sustainability impact,
the named directives aim to promotesustainability impact. This is clarified,
for instance, by Recital 14 SRD II, which
points out that effective ‘and sustainable
shareholder engagement is one of thecornerstones of the corporate governancemodel of listed companies’ and ‘one of
the levers that can help improve thefinancial and non-financial performanceof companies, including as regards
environmental, social and governancefactors”’ This implies that life insurers
should in principle be permitted to engage
for sustainability impact. However, their
engagement must not conflict with theircontractual and other duties (see section
3.4.5).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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4.

ASSET OWNERS’ PUBLIC POLICY ENGAGEMENT WITH A VIEW TO PURSUING SUSTAINABILITYIMPACT

4.1

The following section considers the extent
to which, and on what basis, each type ofAsset Owner is required or permitted touse public policy engagement with a view
to pursuing IFSI.

4.2

Pension funds

4.2.1

Under current EU legislation, there
is no express obligation for pension
funds to use public policy engagementwith a view to pursuing Sustainability
Impact. Moreover, EU legislation neither
specifically permits, nor prohibit
public policy work. Therefore, the legal
framework under current EU law appears
to provide flexibility for pension funds toengage in public policy work with a view
to pursuing sustainability impact.

4.2.2

UCITS and its unit holders, since it may
not result in any quantifiable positiveeffect on the financial return of the UCITS.
In particular, if such public policy work
is paid by funds of the UCITS, incurredcosts may be considered ‘undue’206
where the financed activities do nothave a measurable positive effect onfinancial return. Management companies
may improve the position by seeking
cooperation with other Asset Owners that
reduces costs and increases the likelihoodof the success of public policy engagement.
4.3.3

However, pension funds would needto ascertain that their engagement iscompatible with their legal and regulatory
duties and does not, in particular, conflictwith the ‘best interest’ of their beneficiaries.
Difficulties may arise where such politicalengagement produces material costs borneby current beneficiaries but does not
generate any (measurable) positive financial
effects for them.

4.3.4

4.3

Mutual funds

4.3.1

Under current EU legislation, there is
no explicit obligation for UCITS to use
public policy engagement with a view topursuing sustainability impact.

4.3.2

296

The management company must carryout its business activities in the ‘best
interest’ of the UCITS, which also includes
engagement in public policy work. Public
policy engagement may be difficult toreconcile with the ‘best interest’ of the

In addition, the management company
must not conduct any activities that resultin placing the interests of any group ofunit-holders above the interests of any
other group of unit-holders. Therefore, themanagement company of the UCITS has
to ensure that the pursued success of its
public policy work is beneficial to all unitholders of a UCITS.

engagement complies with their legal
or regulatory duties. This requires, inparticular, that their activities do notconflict with capital requirements orthe ‘best interest’ of their beneficiaries.
Further, the insurer’s public policy
engagement needs to be consistent withdirectors’ duties, if applicable, under
Member State law. Where such public
policy engagement carries a material
cost borne by current beneficiaries with
benefits expected to accrue to otherbeneficiaries, it might conflict with aninsurer’s duties.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

As a result, a duty to use public policy
work to pursue IFSI will likely not arise
and flexibility to do so is limited by thematters described.

France4.4

Insurance undertakings

Netherlands

4.4.1

In our view, general or life insurers are,under current EU law, not generally
required use public policy engagementwith a view to pursuing sustainability
impact. Sector-specific EU legislation
neither expressly permits nor prohibits
such engagement. This suggests that
insurers are, to some extent, free to use
public policy engagement to pursue
sustainability impact.

South Africa

4.4.2

Japan

United Kingdom
United States

GLOSSARY
REFERENCES

However, insurance undertakings would
need to ensure that their public policy
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5.

ESTABLISHING NEW IFSI FUNDS AND AMENDING THE TERMS OF EXISTING ONES

5.1

The following section considers the extent
to which it is possible for an Asset Owner
to set up a fund, policy or other productwith an express IFSI objective. It does notcover general insurance policies as theterms of these are not generally relevantto the insurer’s investment activities.

5.2

Pension funds

5.2.1

Current EU law does not explicitly
prohibit setting up new pension funds
under either IORP or the PEPP Regulation
with an express IFSI objective. The sameshould apply to the introduction of freely
selectable options within existing pension
funds with an IFSI objective. This is also
confirmed by the SFDR, which provides for
specific disclosure obligations in relation
to financial products that promote
environmental or social characteristics
or have sustainable investment as theirobjective.207 However, in such cases, thepension fund would need to observe
general rules, in particular the obligation
to provide sufficient and clear information
to the beneficiary on the specific risk
profile as well as comply, from the date ofapplication, with the disclosure duties set
out in the SFDR.

5.2.2

Furthermore, it might theoretically bepossible to amend the terms of existing
pension schemes to include an IFSI objective.
In practice, the permissibility of such
amendments will mainly be a matter ofMember State law and practice. In addition,member or beneficiary consent may berequired (depending on the structure).

5.3

Mutual funds

5.3.1

EU legislation does not prohibit or restrictsetting up a UCITS with an express
IFSI objective, as long as the statutory297

requirements regarding the investment
policy of the UCITS (eg its restriction
to certain eligible types of transferable
securities) are observed. An IFSI investment
objective could be subordinate or equal
to, or have priority over, a financial
investment objective. However, the Asset
Owner needs to comply with generalregulations or rules such as to informthe beneficiary on the risk profile.
Management companies are also required
to use fair, correct and transparent pricing
models and valuation systems which
may pose difficulties, given that that anassessment of the financial impact ofsustainability factors may require broader
flexibility than current regulation permits.
5.3.2

Existing UCITS may amend and revise
their investment objectives and policy. In
order to do so, the competent authority’s
approval must be obtained.208 Furthermore,
the publication of a renewed prospectus
and key investor information document
is likely to be required.209 Depending on
the Member States’ implementation of
the UCITS Directive in national law, theexisting unit-holders may need to be
involved in approving the amendment.

Duties on those designing, manufacturing andproviding mutual funds
5.3.3

Manufacturers of UCITS may besubject to MiFID II product governancerequirements.210 Among other things,
a manufacturer must ‘identify at a
sufficiently granular level the potential
target market for each financial
instrument and specify the type(s) of
client for whose needs, characteristics
and objectives the financial instrument
is compatible’.211 The manufacturer
must also identify any group of clientsfor whose needs, characteristics andobjectives the financial instrument is notcompatible (the ‘negative target market’).
5.3.4

5.3.5

ESMA establishes five factors that
identify the target market: the type ofclient (eg retail client or professional
client); knowledge and experience;
financial situation (with a focus on theability to bear losses); risk tolerance andcompatibility of the risk/reward profile ofthe product with the target market; andthe client’s objectives and needs.212 Theclient’s objectives and needs comprise theinvestment objectives, including the wider
financial goals of the client. However, they
can be ‘fine-tuned’ by specifying particular
aspects of the investment expectations oftargeted clients. As ESMA notes, a productmay be designed with ‘specific productfeatures to achieve specific investment
objectives, such as […] “green investment”,“ethical investment”, etc as relevant’.213
Thus, the investment manager may specify
the ‘target market’ by integrating ‘green
investment’ but would not be legallyrequired to determine whether a productqualified as ‘green investment’.
According to the amended delegateddirective published by the Commission,214
the requirement for manufacturers tospecify the target market by, and the type(s)of client for whose needs, characteristics
and objectives the product is compatible
with, is extended to include ‘sustainability
preferences’.215 Manufacturers will also
be required to ensure that the productmeets the identified target market’s needs
in relation to sustainability factors.216
This means that the manufacturer willneed to identify the actual sustainability
aspirations of the target market.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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5.3.6

5.3.7

5.3.8

As part of its focus on governancearrangements, the MiFID II Sustainability
Delegated Directive proposes toamend ongoing obligations to review
manufactured financial instruments
to include the financial instrument’s
consistency with the sustainability
preferences of the target market.217
The Commission has highlighted thatchanges to the definition of the target
market should not lead to mis-selling
practices (eg by clearly identifying
investment objectives and sustainability
constraints) but that also in the futurea target market for clients without
sustainability preferences can be
identified.218 Therefore, ‘non-ESG
products’ which comprise ESG-neutral and
ESG-negative products will continue to be
manufactured. For non-ESG products thetarget market will simply lack a reference
to ESG.219

Life insurance products

5.4.1

Current EU law does not prohibit life
insurers from setting up new types of
products that include an express IFSI
objective. Therefore, life insurers are
generally allowed to create policies
specifically including such an objective.

298

5.4.3

5.4.4

Investment managers that distributeunits in UCITS are subject to similar
requirements, eg to ensure that products
and services that are intended to be offeredor recommended are compatible with
the needs and objectives of the identified
target market and an ongoing obligation
to review this compatibility.220 The MiFIDII Sustainability Delegated Directive
proposes to extend also this requirement tosustainability preferences.221

5.4

5.4.2

for specific disclosure obligations inrelation to financial products that promote
environmental or social characteristics
or have sustainable investment as theirobjective.223 Further, Article 8 (3) (c) (ii)
PRIIPs Regulation expressly addresses
PRIIPs which target ‘specific environmental
or social objectives’.

In relation to IBIPs,222 this is confirmed,
for instance, by the SFDR, which provides

The life insurer needs, however, to observe
general legal requirements, such as theobligation to sufficiently and clearly informthe beneficiary on the specific risk profile,
disclosure obligations set out by the SFDR
and information requirements prescribedby the PRIIPs Regulation, as applicable.
In relation to IBIPs, the joint committee of
the ESAs noted that PRIIPs are increasinglyoffered with a focus on target-specificsocial or environmental objectives, and not
only purely financial objectives.224 They
therefore chose to set out some certain
technical advice on specific requirements
for PRIIPs including the following:• where a PRIIP manufacturer targets

environmental or social objectives,
these objectives and how they are to
be achieved should be specific, and thestrategy for achieving the objectives
should be appropriate and proportionate
to the objectives;• the PRIIP manufacturer should clearly

disclose to retail investors the objectives
and how they are to be achieved;• governance and monitoring measures

should be put in place, be proportionate
to the objectives and strategy, and be well
documented; and• regular reviews should be undertaken

on progress.225
5.4.5

The technical advice also provides that‘specific environmental or social objectives

should be treated on equal footingwith other investment objectives; retailinvestors should have full confidence
that where PRIIPs are sold as targeting
environmental or social objectives, this isbacked up by appropriate and sufficient
substance, as with other investment
objectives, in view of the activities of the
PRIIP manufacturer, but also in view ofsupervisory oversight and civil liability’.226
5.4.6

Additionally, EU law does not prohibit
an insurer from amending an insurance
contract to include an express IFSI objective.
Generally, this would, however, require theconsent of the policyholder depending on
the relevant Member State law.

Duties on those designing, manufacturing andproviding life insurance
5.4.7

EU law provides for a product oversightand governance system in relation to
insurance products. Thus, under IDD,
insurance undertakings shall specify,
within a product approval process,an identified target market for each
insurance product and ensure that all
relevant risks to such identified target
market are assessed.227 The Commission
Delegated Regulation (EU) 2017/2358228
further determines that the identificationof the target market shall be carried out
at a sufficiently granular level, taking into
account the characteristics, risk profile,complexity and nature of the insurance
product, and that manufacturers
may, in particular in regard to IBIPs,
identify groups of customers for whoseneeds, characteristics and objectives
the insurance product is generally
not compatible (the ‘negative target
market’).229 Additionally, manufacturers
are required to only design and market
insurance products that are compatible

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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with the needs, characteristics andobjectives of the customers belonging to
the target market.230
5.4.8

5.4.9

Furthermore, the insurance undertaking
shall regularly review the insurance
products it offers or markets to assess
at least whether the product remains
consistent with the needs of the identified
target market.231 Manufacturers that
identify during the lifetime of an
insurance product any circumstances
which are related to the product andmay adversely affect the customer of that
product shall take appropriate action to
mitigate the situation and prevent further
occurrences of the detrimental event.232
The Amendment IDD DelegatedRegulation which has been adopted by theCommission on 21 April 2021 provides,
among other things, for an integrationof sustainability factors into the productoversight and governance requirements.
It requires, in particular, the productapproval process to take into account ‘theobjectives, interests and characteristics ofcustomers, including any sustainabilityrelated objectives’.233 Moreover, theidentification of the respective target
market needs to consider ‘its sustainability
factors’.234 Manufacturers will be required
to assess whether the insurance products
remain consistent with, among otherthings, the ‘objectives, including any
sustainability-related objectives, of theidentified target market’.235

5.4.10 Recital 5 of the Amendment IDD
Delegated Regulation specifies that
manufacturers of insurance products‘should consider sustainability factors
in the product approval process of each
insurance product and in the otherproduct governance and oversightarrangements for each product that is
intended to be distributed to customers
seeking insurance products with asustainability-related profile’.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

299

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6.

INVESTMENT MANAGERS’ DUTIES TO INVEST FOR SUSTAINABILITY IMPACT

6.1

This section considers the extent to which,and in what circumstances, an investment
manager is required or permitted to invest
for sustainability impact on behalf of an
Asset Owner.

6.1.1

6.1.2

6.1.3

300

Typically, an investment manager’s
investment duties and powers areshaped by the terms of its contractual
investment management agreementwith an Asset Owner (IMA) which will
be governed by a Member State law andEU legislation. While, on the whole, the
IMA cannot override the requirements of
EU legislation, it is likely to be the mostimportant element in determining theinvestment manager’s duties and powers.
An investment manager must act
honestly, fairly and professionally inaccordance with the best interests of
its clients.236 In particular, it ‘must
understand the financial instruments
they offer or recommend, assess thecompatibility of the financial instrumentswith the needs of the clients to whom[they provide] investment services, also
taking account of the identified target
market of end clients [...] and ensurethat financial instruments are offered orrecommended only when this is in theinterest of the client’.237
Investing on behalf of an Asset Owner
will generally be the regulated service of
portfolio management. When providing
portfolio management services, it is
the investment manager’s obligation
to obtain the necessary information,
including about investment objectives andrisk tolerance, to enable the investment
manager to manage the Asset Owner’s
assets in accordance with that suitability
assessment (‘suitability test’).238

6.2

Legal obligations with respect tosustainability impact

informed investment decisions. It appears
that there is an expectation that clients whoare sufficiently informed about the featuresof those financial instruments will tend to
express a desire for inclusion of sustainable
instruments in their investments.

Powers of investment and divestment
6.2.1

6.2.2

Suitability is determined by, among
other things, considering the investment
objectives of the client. In doing so, itwould be necessary for the investment
manager to rely on information provided
by the client.
Should the investment objectives be silent
on IFSI, there is currently no duty toproactively ask for the client’s objectives
regarding sustainability under MiFID II239,
but ESMA considers it a ‘good practice’ forinvestment firms to consider non-financial
elements and collect information on theclient’s preferences on ESG factors.240
However, once the MiFID II DelegatedRegulation is amended as provided for in
the Commission Delegated Regulation (EU)…/… of 21.4.2021 amending DelegatedRegulation (EU) 2017/565 as regards theintegration of sustainability factors, risks
and preferences into certain organisational
requirements and operating conditions
for investment firms241, the suitability
assessment pursuant to Article 54 of
MiFID II Delegated Regulation will express
include a requirement to ask a client or
potential client for his or her sustainability
preferences. Sustainability preferences aredefined as a client’s choice as to whether
and, if so, to what extent, one or more ofthree types of financial instruments withdifferent degrees of sustainability-related
ambition (which are defined in the MiFIDII Delegated Regulation) shall be integrated
into his or her investment. The rationale
behind this amended suitability assessment
is to enable clients to understand thosedifferent degrees of sustainability and take

6.2.3

However, the obligation of an investment
manager to ask for the sustainability
preferences of an Asset Owner does notamount to an obligation for an Asset Owner
to have sustainability preferences. Hence,the client can, of course, decide against
the inclusion of any financial instrumentwith sustainability-related ambitions.
Nevertheless, it appears that the European
legislator has concluded that asking clientsfor their preferences will in practiceencourage a greater shift to sustainabilityfactor-related strategies such as IFSI thanmerely allowing investment managers to doso where they consider it appropriate.

Stewardship
6.2.4

Any engagement that is not requiredby the IMA would need to be in the‘best interest’ of the client. Under thesecircumstances, we do not consider there to
be any legal requirement for investment
managers to engage with portfolio
companies to achieve sustainability
impact, except where this relates to
instrumental IFSI.

Public policy engagement
6.2.5

There is no requirement in EU legislation
for an investment manager to use public
policy engagement for IFSI. An investment
manager would, therefore, only berequired to use public policy engagement
to invest for sustainability impact if its
mandate expressly or impliedly required
it to do so.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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6.3

Legal freedom to invest forsustainability impact

Stewardship6.3.3

Powers of investment and divestment
6.3.1

6.3.2

The investment manager’s freedom
to invest for sustainability impact as astandalone objective (ie on an ultimate
ends basis) is limited by the IMA. Wherethe IMA remains silent on IFSI, some levelof flexibility also arises from the duties
applicable to Asset Owners. This means,
where the Asset Owner contemplates
to invest for sustainability impact, theinvestment manager should find anenhanced degree of flexibility.
Generally, investment managers are also
permitted to offer sustainability-focused
products to Asset Owners where there isno distinct objective for IFSI, provided thatthe recommended investments fulfil thesuitability test.

Assuming that the IMA does not expressly
specify what stewardship is permitted,
investment managers will be able toengage for sustainability impact as long
this is compatible with the duty to act
in the client’s best interest. Investment
managers may be reluctant to engage inactivities that reduce the financial returnof investments in the portfolio they
manage during the relevant investment
horizon.

Public policy engagement
6.3.4

In the absence of specific requirementsin the IMA, an investment manager
benefits from a broad flexibility to use
public policy engagement, provided itdoes not charge the associated costs tothe managed portfolio. An investment
manager may also not act against the bestinterests of its clients.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

301

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7.

LEGAL LIABILITY TO THIRD PARTIES FOR THE NEGATIVE SUSTAINABILITY IMPACT OF
ENTERPRISES IN WHICH PORTFOLIOS ARE INVESTED

7.1

This section considers the extent towhich, regardless of the legal rules
under which it is required to operate
and its constitution, an Asset Owner
could be legally liable to third parties
for the negative sustainability impactof a portfolio company and whether aninvestment manager could also be liablebecause of its role in assisting theAsset Owner.

7.1.1

7.1.2

This section does not cover potential
liability under any national laws, which
will be where liability will most likely
arise in practice, but only under specificEU law.
The liability of relevant investors to third
parties for negative sustainability impact
is currently not explicitly contemplated
by EU law. The ECJ to date has notdirectly addressed the legal liability ofan Asset Owner to third parties for thenegative sustainability impact of portfolio
companies. Nor has the ECJ directly
addressed the liability of an investment
manager to third parties for negative
sustainability impact because of its role inassisting the Asset Owner to invest.

Civil and criminal liability
7.1.3

7.1.4

302

Any direct imposition of civil or criminal
liability on Asset Owners and investment
managers through EU regulations ordirectives is unlikely. There is currently
no EU-wide approach to such liability.
Rather, any such liability would have to beaddressed in national legislation.242
In fact, it seems unlikely that Asset
Owners would be held liable to third
parties for the negative sustainability
impact of a portfolio company under

7.1.5

EU law. Such liability for Asset Owners,
generally minority shareholders in a
portfolio company, would entail piercingof the corporate veil. Directives neither
require nor prohibit piercing of thecorporate veil and each Member Stateis generally free to provide for it in its
national legislation. In circumstanceswhere there is no capability to influence
the management of a company’s affairs (asis generally the case with Asset Owners),
such national laws may be foreclosed by
EU primary law. In such cases, piercing of
the corporate veil may have a deterrent
effect on investors and affect their accessto the equity market, thus restricting
both freedom of establishment (Article 49
TFEU) and the free movement of capital(Article 63 TFEU).243

Administrative liability

In the EU framework, as illustrated by
EU competition law, shareholder liability
generally requires the shareholder toexert influence over a company.244 Thus,a ‘pure financial investor’ (an investor
passively holding shares for profit
with no involvement in the company’s
management), like most Asset Owners orinvestment managers, would not be liable
for the actions of its investee portfolio
companies under EU law.245

7.1.7

7.1.6

A comprehensive administrative liability
vis-à-vis the state to remediate certain
damages caused by negative sustainability
impacts or pay for such remediation does
not exist under European legislation.
However, to some extent it may be coveredby the Environmental Liability Directive(or ELD). The ELD establishes a frameworkof strict environmental liability based onthe ‘polluter-pays’ principle, to preventand remedy environmental damage.246 The
ELD obliges operators of certain activities
which have caused environmental damage
to, among other things, implement
remedial measures and bear the costs forsuch measures.247 It does not, however,provide for claims by private parties
against such polluters.248
An ‘operator’ is broadly defined as‘any natural or legal, private or publicperson who operates or controls theoccupational activity or, where this isprovided for in national legislation, towhom decisive economic power over thetechnical functioning of such an activity
has been delegated, including the holder
of a permit or authorisation for suchan activity or the person registering or
notifying such an activity’.249 Relevant
investors may, depending on the nature of
their involvement, be regarded as either
controlling an investee company’s activity
or as having decisive economic powerover the technical functioning of suchan activity.250 Also, a minority investor is
not a priori excluded from being qualified
as operator. However, application will
depend on the national implementation of
the ELD in each Member State.251

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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7.2

Asset Owners

Insurance undertakings

7.2.1

The following section assesses whether, in
addition to the general legal framework,
sector-specific legislation for Asset Owners
addresses legal liability.

7.2.6

Pension funds
7.2.2

7.2.3

Current sector-specific EU law does not
regulate the potential liability of pension
funds for negative sustainability impact.
This also applies to Article 31 PEPP
Regulation, which concerns civil liabilities
of PEPP providers in case of a breach of
information requirements. However, aliability for negative sustainability impact
might arise out of the Member State.
As public awareness of sustainability
issues has grown, the legal liability
risks of pension funds might increase
correspondingly where investment
activities lead to negative sustainability
impact. This may make it reasonable toconsider sustainability impact, including
its financial consequences, in investment
decisions. The specific extent of suchliability risks will, however, depend on theMember State law.

Mutual funds
7.2.4

7.2.5

303

The UCITS Directive, including
accompanying delegated legislation,
does not establish nor does it require
Member States to establish a liability formutual funds in respect of the negative
sustainability impact of a portfolio company.
Any liability risk that the portfolio
company is exposed to as a result of anegative sustainability impact, may,
however, be taken into account as‘sustainability risk’ or other type ofrisk that has a potential impact on thefinancial return of the investee company
when taking the investment decision.

Current sector-specific EU law does not
explicitly address the potential liability of
insurance undertakings for the negative
sustainability impact of a portfolio
company. This also applies to Article 11
PRIIPs Regulation, which provides for a
civil liability of PRIIP manufacturers in theevent of a breach of duty concerning the
key information document of a PRIIP.252

7.2.7

However, a liability might arise under thenational law of the respective Member State.

7.3

Investment managers

7.3.1

Applicable EU legislation, notably MiFID
II, does not provide for any rules underwhich an investment manager would be
liable for breaches of any duty identified
in section 2 that an Asset Owner is subject
to. In relation to UCITS, on the contrary,
the law provides that the liability of the
management company is not affectedby the delegation of functions by the
management company to third parties,
including the investment manager.253

7.3.2

Since this annex concerns the standards
established under EU law only, it does
not consider any contractual or tortious
obligations between the investment
manager and the beneficiaries thatwould make the investment manager
directly liable to beneficiaries. Any suchcontractual or tortious obligations would
be governed by a Member State or third
country law and are therefore out of scopeof this annex.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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8.

THE MEANING OF ‘FINANCIALLY MATERIAL’

8.1

It is important to understand how the law
defines what is ‘financially material’ in
relation to the assessment of sustainability
factors and the period by reference towhich financial materiality must be
measured. Taking account of these factors
in order to pursue financial objectives may
incidentally have sustainability impacts.

8.2

Financial materiality

8.2.1

EU legislation has established the conceptof ‘sustainability risks’ to describe how
ESG and sustainability factors become‘financially material’. In Article 2(22)SFDR, sustainability risks are defined asan ‘environmental, social or governanceevent or condition that, if it occurs,
could cause an actual or a potential
material negative impact on the valueof the investment’. Besides the useof this term for the specification of
disclosure requirements, the conceptof ‘sustainability risk’ is referred toin the legislation which is part of thesustainable finance package publishedby the Commission on 21 April 2021
in order to determine how financiallymaterial ESG and sustainability factors
need to be taken into account in taking
investment decisions.254 Thus, for instance,
the Amendment Solvency II DelegatedRegulation contains a similar definition of‘sustainability risk’ as the SFDR.255

304

8.3

Time period by reference to which‘financial materiality’ is to be assessed

ACKNOWLEDGEMENTS

Mutual funds
8.3.3

Pension funds
8.3.1

8.3.2

Generally, pension fund investments mustseek to achieve financial returns over thelong term so they need to consider the‘best long-term interest’ of beneficiaries‘as a whole’ as part of the PPP. Specifically,
for IORPs, this is also recognised bytheir classification as ‘very long-term
investors’.256 Similarly, in regard to PEPPs,
the term ‘personal pension product’ isdefined as a product which, among otherthings, ‘provides for long-term capital
accumulation’.257
Further, Recital 7 IORP II highlights
the importance of ensuring theintergenerational balance of occupational
pension schemes ‘by aiming to have an
equitable spread of risks and benefits
between generations in occupational
retirement provision’. For PEPP providers,Recital 46 of the PEPP Regulation sets
out that ‘PEPP providers should be able
to opt for an asset allocation that suits
the precise nature and duration of their
liabilities, including those having a longterm horizon’. This indicates that pension
funds must also consider shorter-term
matters. The generally long-term characterof pension funds’ investments implies thatthe financial materiality of sustainability
factors should primarily be assessedover the long-term, considering the time
period over which their liabilities arise. In
addition, pension funds need to consider
the interest of any beneficiaries withshorter-term holding periods. Regarding
PEPPs, the generic accumulation periodvaries from 10 to 40 years.258

8.3.4

Absent any specific provisions, theprinciple of ‘best interest’ for UCITS andtheir unit-holders decides upon the time
period over which an impact on financial
return must be considered. It therefore
appears to be in the best interest ofunit-holders where the financial returnis positively impacted during theirinvestment horizon, which means that
ESG and sustainability considerations
should be taken into account where
they become relevant for the financial
return during the investment horizon ofa unit-holder of the fund concerned (ieinstrumental IFSI).
Usually, the composition of unit-holders
in open-ended funds, such as UCITS, isconstantly changing. The investment
horizon of unit-holders will therefore be
defined as rather short-term.

Insurance undertakings
8.3.5

As a general principle, the time period byreference to which non-life insurers should
assess the ‘financial materiality’ of ESG
factors should, in our view, differ from thetime period relevant for life insurers (ineach case, only in relation to their assets
covering insurance liabilities). EIOPA statedthe view that for ‘(longer-term) life business,the long horizon for cash-flows also meansthat there may be room to consider the
impact of climate change in the calculationof best estimate’.259 Similarly, EIOPA notedthat where ‘undertakings have long-term
assets to match long-term liabilities theyshould consider whether climate change
would impact either their liability to holdthese assets over that time frame or their
expected cash-flows’.260

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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8.3.6

In contrast, for traditional non-life
insurance business, the insurance
cover period typically amounts to 12
months.261 Pursuant to EIOPA, insurance
business ‘whose claims’ occurrence orsettlement periods are short-term might
be less affected. These business models
allow, in theory, for annual repricing
and recalibration. Therefore, the annual
validation of assumptions seems fit for
purpose for short-term obligations’.262
However, EIOPA has pointed out that
non-life insurance undertakings could also
have long-term liabilities and therefore
hold assets over the long term.263

Investment managers
8.3.7

The time period that investment
managers will primarily consider for thedetermination of financial materiality
will depend on the time period applicable
under the relevant investment terms.

ACKNOWLEDGEMENTS

Markus Benzing, Wessel Heukamp, David
Jansen, Daniel Klingenbrunn, Jadwiga Loiko,
Bastian Schuster and David Schwintowski

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

305

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EUROPEAN UNIONCONTENTSFOREWORDSINTRODUCTION
1

Article 288(1) of the Treaty on the Functioning of the European
Union (TFEU).

2

Article 288(2) TFEU.

3

Article 288(3) TFEU.

4		Case C- 41/74, Yvonne van Duyn v Home office, Judgement of the
ECJ of 4 December 1974, para. 12.
5

Articles 290 and 291 TFEU.

corporate sustainability reporting, 21 April 2021, COM(2021) 189
final, 2021/0104 (COD)).
18

See, for example, the 2020 consultation on the RTS conducted by
the EBA, EIOPA and ESMA (the ESAs) in the context of the SFDR
(https://www.esma.europa.eu/press-news/esma-news/esas-consultenvironmental-social-and-governance-disclosure-rules).

19

Regulation (EU) 2019/2088 of the European Parliament and of theCouncil of 27 November 2019 on sustainability‐related disclosures in
the financial services sector, OJ L 317, 9 December 2019, p. 1–16. The
SFDR applies to ‘financial market participants’, a term covering, interalia, (1) insurance companies that make available insurance‐based
investment products, (2) investment firms and credit institutions
providing portfolio management, (3) IORPs, (4) manufacturersof pension products, (5) AIFMs, (6) PEPP-providers and (7) UCITS
management companies (Article 2(1) SFDR ). Certain Asset Owners
are also covered in their role as providers of investment or insurance
advice, ie as ‘financial advisers’ (Article 2(11) SFDR).

6		Directive 2009/65/EC of the European Parliament and the Councilof 13 July 2009 on the coordination of laws, regulations andadministrative provisions relating to undertakings for collective
investment in transferable securities, OJ L 302, p. 32.
7		Directive 2009/138/EC of the European Parliament and of theCouncil on the taking up and pursuit of the business of Insurance
and Reinsurance, OJ L 335, p. 1-155.
8		Directive 2014/65/EU of the European Parliament and of the Councilof 15 May 2014 on markets in financial instruments and amending
Directive 2002/92/EC and Directive 2011/61/EU, OJ L 173, p. 349–496.
9Communication from the Commission to the European Parliament,
the European Council the Council, the European Central Bank, theEuropean Economic and Social Committee and the Committee of
the Regions, Action Plan: Financing Sustainable Growth, 8 March
2018, COM(2018) 97 final.

10

Action Point 7 of the EU Action Plan on Sustainable Finance.

11

Communication from the Commission to the European Parliament,
the European Council the Council, the European Central Bank, theEuropean Economic and Social Committee and the Committeeof the Regions, The European Green Deal, 11 December 2019,
COM(2019) 640 final.

12

https://ec.europa.eu/info/consultations/finance-2020-sustainablefinance-strategy_en.

13

https://ec.europa.eu/info/publications/210421-sustainable-financecommunication_en.

14

Regulation (EU) 2020/852 of the European Parliament and of theCouncil of 18 June 2020 on the establishment of a framework tofacilitate sustainable investment, and amending Regulation (EU)2019/2088, OJ L 198, 22 June 2020, OJ L 198, 22 June 2020, p. 13–43.

15

Commission Delegated Regulation (EU) of 4 June 2021,
supplementing Regulation (EU) 2020/852 of the European
Parliament and of the Council by establishing the technicalscreening criteria for determining the conditions under whichan economic activity qualifies as contributing substantially to
climate change mitigation or climate change adaptation and for
determining whether that economic activity causes no significant
harm to any of the other environmental objectives, C (2021) 2800
final (EU Taxonomy Climate Delegated Act).

16		See, for example, the Regulation (EU) 2019/2088 of the European
Parliament and the Council of 27 November 2019 on sustainability‐
related disclosures in the financial services sector, OJ L 317, 9
December 2019, p. 1–16. as amended by the Taxonomy Regulation.
17

306

See, for example, the Non-Financial Reporting Directive (or NFR
Directive, supplemented by the Guidelines on Non-Financial
Reporting: methodology for reporting non-financial information(2017/C 215/01), OJ C 215, and the Guidelines on non-financial
reporting: Supplement on reporting climate-related information(2019/C 209/01), C/2019/4490. The NFR Directive is now about tobe amended by the Corporate Sustainability Reporting Directive(CSRD) a proposal for which the Commission has published as partof the sustainable finance package published on 21 April 2021
(Proposal for a Directive of the European Parliament and of theCouncil amending Directive 2013/34/EU, Directive 2004/109/EC,
Directive 2006/43/EC and Regulation (EU) No 537/2014, as regards

20

Cf. Article 1 SFDR.

21European Commission, Consultation on the Renewed Sustainable
Finance Strategy, Consultation Document, 8 April 2020, p. 33 (https://
ec.europa.eu/info/consultations/finance-2020-sustainable-financestrategy_en).

22

As regards the details of the content, presentation andmethodologies to be applied to certain information to bedisclosed, the ESAs have been mandated to develop respective
RTS by December 2020 (cf. Article 4(6) and (7), 8(3), 9(5), 10(2),11(4), 13(2) SFDR) to be subsequently adopted as delegated actsby the Commission. Further to public consultation in April 2020,
on 4 February 2021, the ESAs published the ‘Final Report ondraft Regulatory Technical Standards with regard to the content,
methodologies and presentation of disclosures pursuant to Article
2a(3), Article 4(6) and (7), Article 8(3), Article 9(5), Article 10(2) and
Article 11(4) of Regulation (EU) 2019/2088 (2 February 2021, JC 2021
03)’.

23

‘Sustainable investment’ is defined in Article 2(17) SFDR as ‘aninvestment in an economic activity that contributes to an
environmental objective, as measured, for example, by key
resource efficiency indicators on the use of energy, renewableenergy, raw materials, water and land, on the production of waste,
and greenhouse gas emissions, or on its impact on biodiversity andthe circular economy, or an investment in an economic activity
that contributes to a social objective, in particular an investmentthat contributes to tackling inequality or that fosters social
cohesion, social integration and labour relations, or an investment
in human capital or economically or socially disadvantaged
communities, provided that such investments do not significantly
harm any of those objectives and that the investee companies
follow good governance practices, in particular with respect tosound management structures, employee relations, remunerationof staff and tax compliance’ [emphasis added]. The (required
information on the) principle of ‘do no harm’ will be specified infurther delegated acts, see Article 2a SFDR (as amended by the
Taxonomy Regulation).

24

Articles 8 to 10 SFDR.

25

Article 2(22) SFDR.

26

Articles 3, 5 and 6 D SFDR.

27

Article 2(24) SFDR.

28

Articles 4 and 7 SFDR.

29

Article 4(1)(a) SFDR. As regards the content of the statement, see
Article 4(2) SFDR as well as the draft template attached as Annex I to
the ESAs’ draft RTS, p. 49 et seqq. (accessible via https://www.esma.
europa.eu/sites/default/files/jc_2020_16_-_joint_consultation_paper_
on_esg_disclosures.pdf).

30

Article 4(a) and (b) SFDR.

31

Article 4(3) and (4) SFDR.

32

See eg Article 1 SFDR, which sets forth that this Regulation lays
down harmonized rules on ‘transparency with regard to theintegration of sustainability risks and the consideration of adverse
sustainability impacts in their processes’, and Recital 10 SFDR,
which clarifies that this ‘Regulation aims to reduce information
asymmetries in principal-agent relationships with regard to’, interalia, the integration of sustainability risks ‘by requiring financial
market participants and financial advisers to make […] disclosures
to end investors when they act as agents of those end investors(principals)’; see, additionally, Recitals 5, 8, 9 and 23 of the SFDR.

33

Emphasis added.

34

Please refer to sections 2.3.26 et seqq. and 2.4.10 et seqq.

35

European Commission, press release of 21 April 2021, Sustainable
Finance and EU Taxonomy: Commission takes further steps tochannel money towards sustainable activities (accessible via https://
ec.europa.eu/commission/presscorner/detail/en/ip_21_1804).

36		European Commission, press release of 6 July 2021, Commission
puts forward new strategy to make the EU’s financial system moresustainable and proposes new European Green Bond Standard(accessible via https://ec.europa.eu/commission/presscorner/detail/en/ip_21_3405).
37		Commission Delegated Regulation (EU) …/… of 6 July 2021
supplementing Regulation (EU) 2020/852 of the European
Parliament and of the Council by specifying the content andpresentation of information to be disclosed by undertakings
subject to Articles 19a or 29a of Directive 2013/34/EU concerning
environmentally sustainable economic activities, and specifying themethodology to comply with that disclosure obligation, C(2021)
4987 final (Delegated Act supplementing Article 8 of the Taxonomy
Regulation).
38

Annexes to the Commission Delegated Regulation supplementing
Regulation (EU) 2020/852 of the European Parliament and of theCouncil by specifying the content and presentation of information
to be disclosed by undertakings subject to Articles 19a or 29a of
Directive 2013/34/EU concerning environmentally sustainableeconomic activities, and specifying the methodology to comply withthat disclosure obligation, 6 July 2021, C(2021) 4987 final, Annexes 1
to 5.

39		Delegated Act supplementing Article 8 of the Taxonomy Regulation,
p. 2.
40

41

Cf. Article 1(1) of Directive (EU) 2015/849: ‘This Directive aims toprevent the use of the Union’s financial system for the purposes ofmoney laundering and terrorist financing.’ (OJ L 141, 5 June 2015,
p. 73). Also see the first preamble to said Directive: ‘Flows of illicit
money can damage the integrity, stability and reputation of thefinancial sector, and threaten the internal market of the Union as
well as international development. Money laundering, terrorism
financing and organised crime remain significant problems whichshould be addressed at Union level.’Cf. preamble 4 of Council Decision (CFSP) 2020/1999 of 7 December
2020 concerning restrictive measures against serious human rights
violations and abuses, OJ LI 410/13: ‘This Decision establishes aframework for targeted restrictive measures to address serious
human rights violations and abuses worldwide. In that regard, theCouncil emphasises the importance of international human rights
law and of the interaction between international human rights
law and international humanitarian law when considering theapplication of targeted restrictive measures under this Decision.’

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

42		With respect to the scope of the project, please refer to Part B.

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43

Annuities can additionally be subject to Solvency II when provided
by insurance undertakings, see Article 2(1) and(3) (a) (ii) Solvency II;
with regard to insurance companies, please refer to section 2.4.

44

Directive (EU) 2016/2341 of the European Parliament and of theCouncil of 14 December 2016 on the activities and supervision of
institutions for occupational retirement provision (IORPs), OJ L 354,
23 December 2016, p. 37–85.

publishing.service.gov.uk/government/uploads/system/uploads/
attachment_data/file/834207/Investing-in-a-better-wold-full-report.
pdf). Moreover, pursuant to a survey conducted by Bauer/Ruod/
Smeets among 2,507 members of a Dutch pension fund, 42 percent of the members supported a more sustainable investment
policy even if this could negatively affect their investment return, see
Rob Bauer/Tobias Ruod/Paul Smeets Get Real! Individuals prefermore Sustainable Investments, 2018, p. 13 et seq. (accessible via
https://ec.europa.eu/jrc/sites/jrcsh/files/paper_tobias_ruof.pdf).

45

See Article 6(1) IORP II.

46

Regulation (EU) 2019/1238 of 20 June 2019 of the European
Parliament and of the Council of 20 June 2019 on a pan-European
Personal Pension Product (PEPP), OJ L 198, 25 July 2019, p. 1–63.

69

EIOPA, Opinion on the supervision of the management ofenvironmental, social and governance risks faced by IORPs, EIOPABoS-19-248, 10 July 2019.

47

According to Article 74 PEPP Regulation the delegated acts will
apply 12 months after publication in the official Journal of theEuropean Union. Following their adoption by the Commission, therespective acts were published on 22 March 2021.

70

EIOPA, Opinion on the supervision of the management ofenvironmental, social and governance risks faced by IORPs, EIOPABoS-19-248, 10 July 2019, para. 3.9.

48

As explained above (please refer to section 1.7), the form an IORPor PEPP takes is not specified in EU law. The constitution of Asset
Owners and the relevance of that constitution to investment-related
decisions will thus be a matter of Member State law.

49

Article 6(5) and (6) IORP II.

50

Article 2(3) and (6) PEPP Regulation.

51

Article 19(1) IORP II.

52

Cf. Recital 25 IORP II.

53

Article 19(1) (a) IORP II.

54

Article 19(1) (b) IORP II. IORP II does not explicitly define the term‘environmental, social and governance factors’ so it is not entirely
clear what the phrase means although Recital 58 of IORP II refers to
the United Nations-supported Principles for Responsible Investment.

55

IORP II is based on the terminology of ‘ESG factors’ or ‘ESG risks’.
The meaning of these terms is, in our opinion, equivalent to‘sustainability factors’ or ‘sustainability risks’.

71

EIOPA, Opinion on the supervision of the management ofenvironmental, social and governance risks faced by IORPs, EIOPABoS-19-248, 10 July 2019, para. 2.7.

72

Emphasis added. In relation to PEPP providers, see Article 41(1) (a)PEPP Regulation which lays down the necessity to take account ofthe ‘best long-term interests of PEPP savers as a whole’.

73

Cf. Recital 49 PEPP Regulation, pursuant to which PEPP providers‘are encouraged to allocate a sufficient part of their asset portfolio
to sustainable investments in the real economy with long-term
economic benefits, in particular to infrastructure projects andcorporates’.

74

75

See section 2.2.9.

76

Article 34(1) PEPP Regulation.

77

Article 34(4) PEPP Regulation.

78

See Article 19(1) (b) IORP II.

79

Cf. Recital 48 IORP II, and similarly, for PEPP providers, Recital 48
PEPP Regulation.

80

European Commission, Commission Staff Working Document
Impact Assessment for a Proposal for a Regulation of the European
Parliament and of the Council on the establishment of a framework
to facilitate sustainable investment and Proposal for a Regulation of
the European Parliament and of the Council on disclosures relating
to sustainable investments and sustainability risks and amending
Directive (EU) 2016/2341 and Proposal for a Regulation of theEuropean Parliament and of the Council amending Regulation(EU) 2016/1011 on low carbon benchmarks and positive carbon
impact benchmarks, 24 May 2018, SWD(2018) 264 final (Impact
Assessment), para. 2.1.2.

56

Article 21(1) and (2) IORP II.

57

Article 25(1) and (2) (g) IORP II.

58

Article 28(1) IORP II.

59

Article 28(2) (h) IORP II.

60

Article 41(1) PEPP Regulation.

61

Article 41(1) (b) PEPP Regulation.

62

Article 2(33) PEPP Regulation.

63

Article 41(1) (c) and (f) PEPP Regulation.

64

Article 46(1) PEPP Regulation.

65

Article 19(1) (b) IORP II.

66

Cf. Recital 58 IORP II, which states that IORPs are not precluded
from satisfying information requirements by stating that ESG factors‘are not considered in its investments policy’.

81

67

EIOPA, Opinion on the supervision of the management ofenvironmental, social and governance risks faced by IORPs, EIOPABoS-19-248, 10 July 2019, para. 3.2.

82

68

For instance, the UK Department for International Development
determined in its survey for its ‘Investing in a Better World’ projectthat 56 per cent of 6,000 participating individuals would have opted
for a fully or partially sustainable pension by having their savings
invested in a sustainable investment fund, if given the choice, see
UK Department for International Development/Investing in a betterworld project, Investing in a better world: Understanding the UK
public’s demand for opportunities to invest in the Sustainable
Development Goals, 2019, p. 7, 20 (accessible via https://assets.

307

Cf. EIOPA, Opinion on the use of governance and risk assessment
documents in the supervision of IORPs, EIOPA-BoS-19-245, 10 July
2019, Annex 1 para. 6.5 to 6.7.

83

84

Cf. EIOPA, Opinion on the use of governance and risk assessment
documents in the supervision of IORPs, EIOPA-BoS-19-245, 10 July
2019, Annex 1 para. 6.5 to 6.7.
Cf. Pensions Europe, Position Paper on the Commission’s Legislative
Package on Sustainable Finance, 26 November 2018, p. 9 (accessible
via https://www.pensionseurope.eu/system/files/Sustainable%20Finance%20Package%20position%20
paper%20final.pdf).
Cf. Recital 45 IORP II (‘IORPs are very long-term investors. […]Furthermore, in order to protect adequately the rights of members
and beneficiaries, IORPs should be able to opt for an asset
allocation that suits the precise nature and duration of their
liabilities.’).
Cf. Recital 45 IORP II (‘[…] in order to protect adequately the rightsof members and beneficiaries, IORPs should be able to opt for an

asset allocation that suits the precise nature and duration of their
liabilities.’).
85

See eg Article 19(1) (c) and (f) IORP II; in relation to the PEPP
Regulation, see Article 41(1) (c) and (f) PEPP Regulation.

86

PensionsEurope, Position Paper on the Commission’s Legislative
Package on Sustainable Finance, 26 November 2018, p. 7 (accessible
via https://www.pensionseurope.eu/system/files/Sustainable%
20Finance%20Package%20position%20paper.pdf); cf. European
Commission, Impact Assessment, para. 2.1.2.

87

EIOPA, Potential undue short-term pressure from financial
markets on corporates: Investigation on European insurance andoccupational pension sectors, Search for evidence, Year-end 2018,
EIOPA-BOS-19-537, 18 December 2019, para. 171 and 172.

88

This Annex does not cover alternative investment funds because, atthe end of 2019, only 16% of the net asset value of these investment
vehicles was held by retail investors - ESMA, ESMA Annual Statistical
Report: EU Alternative Investment Funds 2020, ESMA50-165-1032,
10 July 2020, p. 6.

89

The UCITS Directive was amended multiple times, most recently
by Directive (EU) 2019/2162 of the European Parliament and of
the Council of 27 November 2019 on the issue of covered bonds
and covered bond public supervision, OJ L 32, 18 December 2019,p. 29. The UCITS Directive has been implemented by the lawsof the members states and supplemented by several DelegatedRegulations and Delegated Directives.

90

Article 1(3) UCITS Directive.

91

Article 1(3) UCITS Directive.

92

This follows from Article 5 (2) sentence 2 of the UCITS Directive; seealso Article 50a UCITS Directive which clearly expresses these two
options.

93

Depending on the Member State laws, for instance, themanagement company, the unit-holder (as a community offractional owners) or the trustee may qualify as legal owner of theassets.

94

Article 14(1)(a) and (b) UCITS Directive.

95

Articles 22 to 29 UCITS Delegated Directive.

96

Article 22(1) UCITS Delegated Directive.

97

A similar interpretation for alternative investment funds (AIFs) is
indicated by Recital 12 of Directive 2011/61/EU on Alternative
Investment Fund Managers, generally describing the interestsof investors of an AIF as the ‘investors’ interests in their specificcapacity as investors of the AIF, and not their individual interests’.

98

Article 22(4) UCITS Delegated Directive.

99

Article 23(1) UCITS Delegated Directive.

100

Article 23(2) UCITS Delegated Directive.

101

Article 23(3) UCITS Delegated Directive.

102

European Commission, Impact Assessment, p. 17.

103

Article 51(1) UCITS Regulation in conjunction with Article 38 et seq.
UCITS Delegated Directive as it will be amended by Commission
Delegated Regulation (EU) .../… of 21 April 2021 amending Directive
2010/43/EU as regards the sustainability risks and sustainability
factors to be taken into account for Undertakings for Collective
Investment in Transferable Securities (UCITS) (C(2021) 2617 final).

104

Cf. European Commission, Impact Assessment, p. 39: ‘Some entities,
in fact, do not analyse these factors, […] because they confuse ESG
integration with ethical investing, which implies accepting lower
risk-adjusted returns, which would not be in the best interest of
their clients/beneficiaries’ (emphasis added).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

EUROPEAN UNIONCONTENTSFOREWORDSINTRODUCTION
105

European Commission, Impact Assessment, para. 2.1.2.

106

Cf. 2005 Freshfields Report, p. 13; European Commission, DG
Environment, Resource Efficiency and Fiduciary Duties of Investors,
Final Report, ENV.F1/ETU/2014/0002, Rec. 2.2.; OECD, Investment
governance and the integration of environmental, social andgovernance factors, 2017, p. 50.

and of the Council on the taking up and pursuit of the businessof Insurance and Reinsurance, OJ L 12, 17 January 2015, p. 1–797(Solvency II Delegated Regulation).
128

Commission Delegated Regulation amending Delegated Regulation(EU) 2015/35 as regards the integration of sustainability risks in thegovernance of insurance and reinsurance undertakings, C(2021)
2628 final, 21 April 2021 (Amendment Solvency II DelegatedRegulation).

129

Commission Delegated Regulation amending DelegatedRegulations (EU) 2017/2358 and (EU) 2017/2359 as regards theintegration of sustainability factors, risks and preferences into the
product oversight and governance requirements for insurance
undertakings and insurance distributors and into the rules on
conduct of business and investment advice for insurance-based
investment products, C(2021) 2614 final, 21 April 2021 (Amendment
IDD Delegated Regulation).

107

Article 22(1) UCITS Delegated Directive.

108

Article 14(1)(a) and (b) UCITS Directive.

109

Article 22(2) UCITS Delegated Directive.

110

European Commission Delegated Directive (EU) .../... of 21 April 2021
amending Directive 2010/43/EU as regards the sustainability risks
and sustainability factors to be taken into account for Undertakings
for Collective Investment in Transferable Securities (UCITS), Ref. C(2021) 2617 final (UCITS ESG Delegated Directive). The final draft was
published on 21 April 2021 as part of the EU Sustainable FinancePackage.

130

EIOPA-BoS-19/241, 30 September 2019.

111

Cf. Recital 3 and 6 UCITS ESG Delegated Directive.

131

EIOPA-BoS-19/172, 20 April 2019.

112

Article 23(5) UCITS Delegated Directive, as amended by Article 1(7)UCITS ESG Delegated Directive.

132

Article 132(1) Solvency II.

133

Article 132(2) subparagraph 1 Solvency II.

134

Article 132(2) subparagraph 2 Solvency II.

135

Article 132(2) subparagraph 3 Solvency II.

136

Article 132(2) subparagraph 4 Solvency II.

137

Article 132(4) subparagraphs 3 and 4 Solvency II (‘Assets shall beproperly diversified in such a way as to avoid excessive relianceon any particular asset, issuer or group of undertakings, or
geographical area and excessive accumulation of risk in theportfolio as a whole. Investments in assets issued by the same
issuer, or by issuers belonging to the same group, shall not expose
the insurance undertakings to excessive risk concentration’”).

113

For a definition, see section 1.15.

114

ESMA, Consultation Paper on integrating sustainability risks andfactors in the UCITS Directive and AIFMD, ESMA34-45-569, 19
December 2018, para. 13.

115

Article 23(6) UCITS Delegated Directive, as amended by Article 1(7)UCITS ESG Delegated Directive.

116

For a definition, see section 1.16.

117

There may, however, be differences in details. The Commission statesthat sustainability risks would need to be assessed ‘mainly over thelong term’ and this may indicate that such risks need to be assessedbeyond the typical investment horizon of individual investors. In
addition, assessing sustainability risks may be considered a ‘broader
concept’ since the risks to the performance of the portfolio are notnecessarily linked to the activities of individual portfolio companies.
European Commission, Impact Assessment, p. 44 et seq.

118

See section 1.16.

119

In this regard, Recital 12 SFDR states that the SFDR ’maintains
the requirements for financial market participants [...] to act in
the best interest of end investors, including but not limited to,
the requirement of conducting adequate due diligence prior to
making investments’.

138

Article 1(6) Amendment Solvency II Delegated Regulation.

139

Article 1(2) and (3) Amendment Solvency II Delegated Regulation.

140

Article 1(4) Amendment Solvency II Delegated Regulation.

141

Article 29 Solvency II Delegated Regulation.

142

Article 17(1) IDD.

143

Article 20(1) subparagraph 2 IDD.

144

Commission Delegated Regulation (EU) 2017/2359 of 21 September
2017 supplementing Directive (EU) 2016/97 with regard to
information requirements and conduct of business rules applicableto the distribution of insurance-based investment products.

120

Article 22(4) UCITS Delegated Directive.

121

Article 23(2) UCITS Delegated Directive.

145

Amendment IDD Delegated Regulation, p. 6.

122

It may be noted that pursuant to Article 5(5) UCITS DelegatedDirective, as amended by Article 1(3) UCITS ESG Delegated Directive,
it is proposed to oblige management companies to have thenecessary resources and expertise for the effective integration ofsustainability risks.

146

Article 2(3) (a) Amendment IDD Delegated Regulation.

147

EIOPA, EIOPA’s technical advice on the integration of sustainability
risks and factors in the delegated acts under Solvency II and IDD,EIOPA BoS-19/172, 30 April 2019, p. 20.

123

Article 22(3) UCITS Delegated Directive.

124

See section 1.16 et seq.

125

Directive (EU) 2016/97 of the European Parliament and of theCouncil of 20 January 2016 on insurance distribution (recast), OJ L
26, 2 February 2016, p. 19 (IDD).

126

Regulation (EU) No 1286/2014 of the European Parliament and theCouncil of 26 November 2014 on key information documents for
packaged retail and insurance-based investment products, OJ L 352,
9 December 2014, p. 1–23 (PRIIPS Regulation).

127

Commission Delegated Regulation (EU) 2015/35 of 10 October 2014
supplementing Directive 2009/138/EC of the European Parliament

308

154

EIOPA, Sustainability within Solvency II, p. 5; EIOPA, EIOPA’s
technical advice on the integration of sustainability risks andfactors in the delegated acts under Solvency II and IDD, EIOPA
BoS-19/172, 30 April 2019, p. 21. Cf. EIOPA, Guidelines on systemof governance, EIOPA-BoS-14/253, 2014, Guideline 29, p. 13 et seq.:
The ‘undertaking should regularly review and monitor the security,
quality, liquidity and profitability of the portfolio as a wholeby considering at least: […] (d) the characteristics of the assets
including: […] (iv) sustainability’.

155

EIOPA, Sustainability within Solvency II, p. 5; EIOPA, EIOPA’s technicaladvice on the integration of sustainability risks and factors in thedelegated acts under Solvency II and IDD, EIOPA BoS-19/172, 30
April 2019, p. 23 et seq.

156

EIOPA, Sustainability within Solvency II, p. 5, 12 et seq.; EIOPA,EIOPA’s technical advice on the integration of sustainability risks andfactors in the delegated acts under Solvency II and IDD, EIOPA BoS19/172, 30 April 2019, p. 24.

157

Cf. Amendment Solvency II Delegated Regulation, p. 1.

158

Article 1(1) Amendment Solvency II Delegated Regulation.

159

EIOPA, EIOPA’s technical advice on the integration of sustainability
risks and factors in the delegated acts under Solvency II and IDD,EIOPA BoS-19/172, 30 April 2019, para. 112.

160

EIOPA, EIOPA’s technical advice on the integration of sustainability
risks and factors in the delegated acts under Solvency II and IDD,EIOPA BoS-19/172, 30 April 2019, para. 115.

161

EIOPA, EIOPA’s technical advice on the integration of sustainability
risks and factors in the delegated acts under Solvency II and IDD,EIOPA BoS-19/172, 30 April 2019, para. 112.

162

Recital (6) Amendment Solvency II Delegated Regulation.

163

EIOPA, EIOPA’s technical advice on the integration of sustainability
risks and factors in the delegated acts under Solvency II and IDD,EIOPA BoS-19/172, 30 April 2019, para. 116.

164

EIOPA, EIOPA’s technical advice on the integration of sustainability
risks and factors in the delegated acts under Solvency II and IDD,EIOPA BoS-19/172, 30 April 2019, para. 119.

165

Cf. EIOPA, EIOPA’s technical advice on the integration ofsustainability risks and factors in the delegated acts under Solvency
II and IDD, EIOPA BoS-19/172, 30 April 2019, p. 11.

166

EIOPA, Sustainability within Solvency II, p. 5, 12.

167

EIOPA, Sustainability within Solvency II, p. 5, 13. In its ’Discussion
Paper on Non-Life Underwriting and Pricing in Light of Climate
Change’ (EIOPA-BoS-20/669, 10 December 2020, p. 14), EIOPA
has argued that the investment landscape relevant for non-life
undertakings would be influenced by climate change thereby
implying that investments of (typically shorter-term) non-life
insurance business may also be subject to climate change-relatedrisks.

168

See discussion of collective action in Part B.

148

EIOPA, opinion on sustainability within Solvency II, EIOPABoS-19/241, 30 September 2019 (EIOPA, Sustainability within
Solvency II), p. 11.

169

EIOPA, Final Report on Public Consultation No. 14/017 on Guidelines
on system of governance, EIOPA-BoS-14/254, 28 January 2015,
explanatory text to Guideline 29, para. 2.142.

149

EIOPA, Sustainability within Solvency II, p. 5.

170

150

EIOPA, Sustainability within Solvency II, p. 5.

151

EIOPA, Sustainability within Solvency II, p. 5.

EIOPA, Final Report on Public Consultation No. 14/017 on Guidelines
on system of governance, EIOPA-BoS-14/254, 28 January 2015,
explanatory text to Guideline 29, para. 2.142.

152

EIOPA, Sustainability within Solvency II, p. 5.

171

153

EIOPA, EIOPA’s technical advice on the integration of sustainability
risks and factors in the delegated acts under Solvency II and IDD,EIOPA BoS-19/172, 30 April 2019, para. 101.

EIOPA, Final Report on Public Consultation No. 14/017 on Guidelines
on system of governance, EIOPA-BoS-14/254, 28 January 2015,
explanatory text to Guideline 29, para. 2.143.

172

EIOPA, Sustainability within Solvency II, p. 5, 14.

173

EIOPA, Sustainability within Solvency II, p. 5, 12.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

EUROPEAN UNIONCONTENTSFOREWORDSINTRODUCTION
174

Directive 2007/36/EC of the European Parliament and of the Councilof 11 July 2007 on the exercise of certain rights of shareholders inlisted companies, OJ L 184, 14 July 2007, p. 17–24; Member States
may exempt, among others, UCITS from the application of the SRD(Article 1(3) (a) SRD). However, please note that Member Statescannot exempt UCITS from the stewardship obligations set out in
Chapter Ib SRD.

175

Article 1(1) SRD.

176

Directive (EU) 2017/828 of the European Parliament and of theCouncil of 17 May 2017 amending Directive 2007/36/EC as regards
the encouragement of long-term shareholder engagement, OJ L
132, 20 May 2017, p. 1–25.

177

Institutional investors comprise life assurance undertakings andreinsurance undertakings that carry out activities covering lifeinsurance obligations and pension funds (Article 2(e) SRD).

178

Asset managers comprise UCITS and investment firms providing
portfolio management services (Article 2(f) SRD).

179

Article 1(6) SRD.

180

Recital 15 SRD II.

181

Recital 14 SRD II.

182

European Commission, Action Plan, para. 1.3.

183

ESMA, Report on undue short-term pressure on corporations,
ESMA30-22-762, 18 December 2019, para. 191.

184

ESMA, Report on undue short-term pressure on corporations,
ESMA30-22-762, 18 December 2019, para. 202.

185

Directorate-General for Justice and Consumers (European
Commission), EY, Study on directors’ duties and sustainablecorporate governance, Final Report, July 2020, para. 3.2.2. Shorttermism is assessed by a comparison of the amount of net corporate
funds used for pay-outs to shareholders compared to the amountused for the creation of value for the firm (such as infrastructure,
workers training, research & developments and investments into
sustainability but not how pay-outs are reinvested) (para. 3.1.1.1.).

186

Directorate-General for Justice and Consumers (European
Commission), EY, Study on directors’ duties and sustainablecorporate governance, Final Report, July 2020, para. 3.2.

187

Article 3g(1) SRD.

188

Relevant matters also comprise strategy, financial and non-financial
performance, risk and capital structure.

189

Article 3g(1) SRD.

190

While the SRD II clearly aims at improving companies’ sustainability
impact (‘greater involvement of shareholders in corporate
governance is one of the levers that can help improve thefinancial and non-financial performance of companies, including
as regards environmental, social and governance factors,
in particular as referred to in the Principles for Responsible
Investment, supported by the United Nations. In addition,
greater involvement of all stakeholders, in particular employees,
in corporate governance is an important factor in ensuring amore long-term approach by listed companies that needs to be
encouraged and taken into consideration.’ (Recital 14 SRD II)), it
does not provide for specific obligations to pursue that aim actively.

191

See, for example, Consumer Detergents (Case COMP/39579),
Commission Decision of 13 April 2011, C(2011) 2528 final, para. 53.

192

Article 101(3) TFEU.

193

See https://ec.europa.eu/competition/information/green_deal/index_en.html.

194

See for example, the Dutch competition authority’s 2015 decisionthat the sustainability benefits produced by the ‘Chicken of

309

Tomorrow’ animal welfare standards initiative did not outweighits anti-competitive costs and was therefore irreconcilable with
Dutch and EU competition law (‘ACM’s analysis of the sustainability
arrangements concerning the “Chicken of Tomorrow”’, ACM/
DM/2014/206028, 26 January 2015). See also, the Dutch competition
authority’s decision that the industry association Energie Nederland’splans to close down five coal power plants was irreconcilable
with Dutch and EU competition law (‘Analysis by the Netherlands
Authority for Consumers and Markets of the planned agreement on
closing down coal power plants from the 1980s as part of the Socialand Economic Council of the Netherlands’ SER Energieakkoord’,
26 September 2013). Conversely, see CECD (Case IV.F.1/36.718)
Commission Decision 2000/475/EC [2000] OJ L187/47 where theEuropean Commission held an agreement to discontinue lessenergy-efficient washing machines did not infringe EU competition
law as it provided greater collective environmental benefits (asquantified in monetary terms) than the increase in costs.
195

196

See Joined Cases C-395 and 379/95P, Commission and France
v. Ladbroke Racing [1997] ECR I-6265, para. 33 and 34). See also
EU Commission decision in Case AT.39258 – Airfreight, where
encouragement of coordination on fuel surcharges among airlines
by a civil aviation regulator was not accepted as a defence.
See Commission Notice 2001/C 3/02, Guidelines on the applicabilityof Article 81 of the EC Treaty to horizontal cooperation agreements,
OJ C 003, p. 2, para. 185. Note, however, that the subsequent
iteration of these guidelines no longer separately addresses
environmental agreements (Guidelines on the applicability of Article
101 of the Treaty on the Functioning of the European Union tohorizontal cooperation agreements, OJ C 11, p. 1, para. 18).

197

See, for example, DSD (Case COMP/34493), Commission Decision
2001/837/EC [2001] OJ L319/1, para. 114.

198

The most progressive (draft) guidelines to date addressing theinterplay of competition law and collaborations for sustainability
are by the Dutch competition regulator: https://www.acm.nl/sites/
default/files/documents/2020-07/sustainability-agreements%
5B1%5D.pdf. The EU Commission is currently looking into the same
issues as part of the review of the two Horizontal Block Exemption
Regulations and the Horizontal Co-operation Guidelines. Further
guidance by other major authorities, such as the US Departmentof Justice or the CMA, would contribute significantly to the debate.
The latter notes in its annual report for 2021: ‘We are continuing todevelop capability to ensure that when delivering our statutoryfunctions, we act in a way which supports the transition to a low
carbon economy’ and ‘we will communicate better to ensurethat businesses engaged in sustainability initiatives know how
to comply with competition and consumer law and do notunnecessarily shy away from those initiatives on the basis ofunfounded fears of being in breach of the law.’

208

Article 5(6) UCITS Directive.

209

Articles 72 and 82 UCITS Directive.

210

Article 16(3) and 24(2) MiFID II; Articles 9 and 10 MiFID II DelegatedDirective. UCITS management companies are not required toobserve the MiFID II product governance obligations where they do
not provide investment non-core services. On the other hand, an
investment manager that collaborates with a UCITS managementcompany in setting up a fund may qualify as co-manufacturer of the
UCITS, as indicated by ESMA (ESMA, Guidelines on MiFID II productgovernance requirements, Final Report, ESMA35-43-620, 2 June
2017, para. 60).
Article 9(9) subparagraph 1 MiFID II Delegated Directive.
ESMA, Guidelines on MiFID II product governance requirements,
Final Report, ESMA35-43-620, 2 June 2017, para. 18.

213

ESMA, Guidelines on MiFID II product governance requirements,
Final Report, ESMA35-43-620, 2 June 2017, para. 18.

214

Commission Delegated Directive (EU) .../… of 21 April 2021 amending
Delegated Directive (EU) 2017/593 as regards the integration ofsustainability factors into the product governance obligations C(2021) 2612 final (MiFID II Sustainability Delegated Directive).

215

Article 9(9) MiFID II Delegated Directive, as amended by Article
1(2) (a) MiFID II Sustainability Delegated Directive.

216

Article 9(11) (b) MiFID II Delegated Directive, as amended by Article
1(2) (b) MiFID II Sustainability Delegated Directive.

217

Article 9(14) MiFID II Delegated Directive, as amended by Article
1(2) (c) MiFID II Sustainability Delegated Directive.

218

Draft MiFID II Sustainability Delegated Directive, Explanatory
Memorandum, section 2.

Australia

219

ESMA, Consultation Paper on integrating sustainability risks andfactors in MiFID II, ESMA35-43-1210, 19 December 2018, para. 10.

Brazil220

Article 10(2) and (5) MiFID II Delegated Directive.

Canada221

Article 10(2) and (5) MiFID II Delegated Directive, as amended by
Article 1(3) MiFID II Sustainability Delegated Directive.

China

222

Cf. Article 2(12) (c) SFDR.

223

See Articles 8 et seq. SFDR.

224

Joint Committee of the European Supervisory Authorities, joint
technical advice on the procedures used to establish whether a
PRIIP targets specific environmental or social objectives pursuant
to Article 8 (4) of Regulation (EU) No 1286/2014 on key information
documents (KID) for packaged retail and insurance-based
investment products (PRIIPs), JC 2017 43, 28 July 2017 (Joint
Committee of the ESAs, Joint Technical Advice), p. 5.

MAR.

225

Joint Committee of the ESAs, Joint Technical Advice, p. 9 et seq.

Transparency Directive.

226

Joint Committee of the ESAs, Joint Technical Advice, p. 8.

201

Directive 2004/25/EC of the European Parliament and of the Councilof 21 April 2004 on takeover bids, OJ L 142, 30 April 2004, p. 12.

227

Article 25(1) subparagraph 3 IDD.

228

Commission Delegated Regulation (EU) 2017/2358 of 21 September
2017 supplementing Directive (EU) 2016/97 of the European
Parliament and of the Council with regard to product oversight andgovernance requirements for insurance undertakings and insurance
distributors (Commission Delegated Regulation (EU) 2017/2358).

229

Article 5(1) and (2) Commission Delegated Regulation (EU)2017/2358.

230

Article 5 (3) Commission Delegated Regulation (EU) 2017/2358.

231

Article 25(1) subparagraph 4 IDD. Additionally, cf. Article 7
Commission Delegated Regulation (EU) 2017/2358.

203

Article 21(1) UCITS Delegated Directive.

204

CESR, CESR’s technical advice to the European Commission on
the level 2 measures related to the UCITS management company
passport, CESR/09-963, 28 October 2009, para. 71.

205

Indeed, it is possible to envisage circumstances where abstention
is chosen as a way of expressing Asset Owner displeasure with aproposed shareholder resolution for IFSI related reasons.

206

Article 22(4) UCITS Delegated Directive.

207

See Articles 8 et seq. SFDR.

A. INVESTING FORSUSTAINABILITY IMPACT

212

200

Cf. Article 2(e) (ii) SRD.

EXECUTIVE SUMMARY

211

199

202

ACKNOWLEDGEMENTS

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

EUROPEAN UNIONCONTENTSFOREWORDSINTRODUCTION
232

Article 7(3) Commission Delegated Regulation (EU) 2017/2358; cf.
EIOPA, Preparatory Guidelines on product oversight and governancearrangements by insurance undertakings and insurance distributors,
EIOPA-BoS-16-071, 18 March 2016, Guideline 9.

233

Article 1(1) Amendment IDD Delegated Regulation.

234

Article 1(2) Amendment IDD Delegated Regulation (with respect to
Article 5(1) Commission Delegated Regulation (EU) 2017/2358).

235

Article 1(3) Amendment IDD Delegated Regulation.

236

Article 24(1) MiFID II.

237

Article 24(1) subparagraph 2 MiFID II.

238

Article 25(2) MiFID II.

239

The ‘suitability test’ is described in Article 54 MiFID II DelegatedRegulation.

240

ESMA, Guidelines on certain aspects of the MiFID II suitability
requirements, ESMA35-43-1163, 6 November 2018, para. 28.
As noted above, we consider that ESG factors are equivalent to/encompass sustainability factors.

241

Commission Delegated Regulation (EU) …/... of 21 April 2021
amending Delegated Regulation (EU) 2017/565 as regards theintegration of sustainability factors, risks and preferences into certain
organisational requirements and operating conditions for investment
firms, - C(2021) 2616 final (MIFID II Delegated Regulation).

242

By way of example, Directive 2008/99/EC of the European Parliamentand of the Council of 19 November 2008 on the protection of theenvironment through criminal law only sets a minimum standardof environmental protection. Although the directive itself makes noreference to the criminal liability of relevant investors, and seems
unlikely on its face to create such a liability, Member States have adegree of discretion in implementing any such criminal sanction
into the national criminal law system, including rules on inciting,aiding and abetting. Any extension of liability to relevant investors
therefore depends on implementation under national law.

243

See Case C-81/09, Idryma Typou AE v Ypourgos Typou kai Meson
Mazikis Enimerosis, Judgment of the Court (Second Chamber) of 21
October 2010.

244

See Case T-419/14, The Goldman Sachs Group, Inc v European
Commission, Judgment by the General Court of the European Unionof 12 July 2018.

245

See Case T-419/14, The Goldman Sachs Group, Inc v European
Commission, Judgment by the General Court of the European Unionof 12 July 2018.

246

Article 1 ELD. The polluter-pays principle is part of EU primary law,see article 191(2) TFEU: ‘Union policy on the environment […] shallbe based on the precautionary principle and on the principles thatpreventive action should be taken, that environmental damage
should as a priority be rectified at source and that the polluter
should pay’.

247

Articles 6 to 9 ELD.

248

Article 3(3) ELD.

249

Article 2(6) ELD.

250

On the possibility of a broad interpretation of the term ‘operator’
see the ‘Study on Environmental Liability of Companies’, May 2020,
commissioned by the European Parliament’s Policy Department
for Citizens’ Rights and Constitutional Affairs, p. 31 et seq.; UNEP
Inquiry Working Paper 16/07, Lenders and Investors Environmental
Liability – How Much is Too Much, April 2016, p. 6, 22; Bergkamp, The
Environmental Liability Directive and Liability of Parent Companies
for Damage Caused by Their Subsidiaries, European Company Law
13, no. 5 (2016), p. 184 et seq.

310

251

For France and the Netherlands, please refer to the Dutch andFrench annexes.

252

Cf. Joint Committee of the ESAs, joint technical advice, p. 10 et seq.

253

Article 13(2) UCITS Directive.

254

See sections 2.3.24 et seq. and 2.4.5(b) et seq.

255

In Article 1(1) Amendment Solvency II Delegated Regulation,‘sustainability risk’ is defined as ‘an environmental, social or
governance event or condition that, if it occurs, could cause
an actual or a potential negative impact on the value of theinvestment or on the value of the liability’.

256

Recital 45 and 48 IORP II.

257

Article 2(1) (b) PEPP Regulation.

258

Cf. Commission Delegated Regulation (EU) 2021/473 of
18 December 2020 supplementing Regulation (EU) 2019/1238of the European Parliament and of the Council with regard toregulatory technical standards specifying the requirements on
information documents, on the costs and fees included in thecost cap and on risk-mitigation techniques for the pan-European
Personal Pension Product, OJ L/99, 22 March 2021, p. 1 (PEPP
Regulatory Technical Standards), Article 4(3), Annex 1 No. 21(d);EIOPA, pan-European Personal Pension Product (PEPP): Regulatory
and Implementing Technical Standards as well as Advice on
Delegated Acts – Impact Assessment, EIOPA-20-504, 14 August
2020, p. 5, 8; additionally, cf. Article 15(2) PEPP Regulatory TechnicalStandards setting out that when using life-cycling as risk-mitigation
technique, PEPP providers shall design the life-cycling in such a way
as to ensure that the PEPP savers furthest away from the expected
end of the accumulation phase invest in long-term investments
whereas for the PEPP savers closest to the expected end of theaccumulation phase, the PEPP provider shall ensure that theinvestments are, inter alia, predominantly liquid.

259

EIOPA, Sustainability within Solvency II, para. 4.10.

260

EIOPA, Sustainability within Solvency II, para. 4.15. Additionally,
EIOPA points out that ‘the medium to long-term impacts ofclimate change cannot fully be captured in the Solvency II capitalrequirements’ which are calibrated on the basis of a one-year time
horizon; however, EIOPA does not consider that the time horizon
relevant for capital requirements should be changed, but is ratherof the opinion that additional tools should be introduced to capture
impacts of climate change; see EIOPA, Sustainability within Solvency
II, para. 4.41 et seq.

261

EIOPA, Sustainability within Solvency II, para. 1.11.

262

EIOPA, Sustainability within Solvency II, para. 4.9.

263

EIOPA, EIOPA’s technical advice on the integration of sustainability
risks and factors in the delegated acts under Solvency II and IDD,EIOPA BoS-19/172, 30 April 2019, para. 28.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union

FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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1.

INTRODUCTION

1.1

For the purposes of this annex, we haveconsidered the legal and regulatory
framework applicable in France as at 31
January 2021.

1.1.1

As discussed in the main body of thereport, the expression ‘Investing for
Sustainability Impact’ (IFSI) is not a
precisely defined legal expression, and it
is important to emphasise that the law inFrance does not reference it in that way.
Rather, the expression is used here as a
type of ‘conceptual net’ to catch any legal
duty or discretion on the part of asset
owners or their investment managers
to pursue one or more sustainability
impact objectives of any sort, whether
in order to protect or enhance thefinancial performance of their investment(instrumental IFSI) or otherwise (ultimate
ends IFSI).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

311

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2.

ASSET OWNERS’ USE OF POWERS OF INVESTMENT AND DIVESTMENT TO INVEST FORSUSTAINABILITY IMPACT

2.1

The following section considers theextent to which and in whatcircumstances, each type of Asset Owneris (a) legally required or (b) legallypermitted or able to use its powers ofinvestment and divestment to IFSI.

2.2

2.2.3

Pension funds

Types of pension fund covered
General pension plans
2.2.1

2.2.2

The French pension system is primarily apublic system relying on old-age insurance
plans that are mandatory and financed
on a pay-as-you-go basis. The system,
which varies across industries, features
mandatory plans covering all workers:
basic pension plans (régimes de base) andcomplementary pension plans (régimes
complémentaires obligatoires).

private sector employees (salariés) and selfemployed workers, including the generalold-age pensions regime (régime général)and the agricultural employees old-age
pensions regime (régime des salariés agricoles);these pension plans cover approximately 70
per cent of French workers1;

312• complementary pension plans for private• the AGIRC-ARRCO federation, which is

sector employees, including in particular
the AGIRC-ARRCO plan,2 which primarily
applies to private sector and agricultural
employees covered by the general oldage pensions regime or the agricultural
employees old-age pensions regime; andin charge of operating one of the main
complementary pension plans.

There are no separate complementary
pension plans for public sector employees
and other workers covered by ad hocplans (régimes spéciaux), as the relevant
basic pension plans include both basic
and complementary elements. However,specific categories of public sector
employees are covered by additional
pension plans (retraite additionnelle).

• basic plans for independent workers

primarily cover public sector employees(fonctionnaires) as well as employees

is in charge of investing with a view tocreating reserves for the French basic
pension system; andindependent workers, including inparticular the 10 sections of the Caisse
nationale d’assurance vieillesse des professions
libérales (CnavPL), which applies toprofessionals (professions libérales), thecomplementary plan covering farmers(exploitants agricoles), as well as the specificcomplementary pension plans applicableto lawyers and self-employed workers.

• general old-age insurance plans covering• ad hoc plans (régimes spéciaux), which• Fonds de réserve pour les retraites (FRR), which

Complementary pension plans come inaddition to basic pension plans and are
split into two main categories:• complementary standard plans for

There are approximately 20 basic pension
plans, which can be split into three categories:(travailleurs indépendants), covering various
categories of independent workers (eglawyers, doctors, pharmacists, craftspeople,
architects, professional accountants etc);
these pension plans cover approximately 13
per cent of French workers1;

of public-sector companies and specificactivities such as miners, railroad
workers, sailors etc); these pension planscover approximately 17 per cent ofFrench workers1.

2.2.4

The above pension plans are managedby 35 different pension plan operators(organismes de retraites). Some ofthese operators manage basic andcomplementary plans; some others

manage either a basic plan or acomplementary plan. This annex
focuses only on two prominent French
pension institutions:

2.2.5

FRR is a public administrative
institution (établissement public à caractère
administratif) created by law n°2001624 dated 17 July 20013. Its mission
is to invest monies entrusted to it by
the public authorities with the aim offinancing the basic pension system4. FRR
is governed by an executive board anda supervisory board. Members of thesupervisory board include members ofparliament, employees’ and employers’
representatives, representatives of theFrench administration and individuals
with recognised credentials in fields
that are relevant to FRR’s business. The
supervisory board is notably responsiblefor defining, upon the proposal of theexecutive board, the FRR’s general
strategic assets allocation, in accordancewith the objective and timeframe foruse of the FRR’s resources. The executive
board is responsible for the operationof the FRR. It implements the FRR’s
investment policy guidelines and ensurescompliance with them and reports
regularly to the supervisory board on
the operation of the FRR, in particularproviding information on the way in

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

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which investment policy guidelines take
into account ESG considerations.
2.2.6

2.2.7

2.2.8

313

the articles of association and regulation(statuts et règlement) of the AGIRC-ARRCO
federation and the financial guidelines(règlement financier – AGIRC-ARRCO
financial guidelines) that are adopted fromtime to time by the board of the AGIRCARRCO federation. The AGIRC-ARRCO
federation and AGIRC-ARRCO Pension
Institutions can manage the assets of theplan either directly or through investment
managers, which must contractuallyagree to comply with the AGIRC-ARRCO
financial guidelines8.

FRR does not directly manage its portfolio
but rather regularly appoints investment
managers through calls for tenders.
Investment managers are required tocomply with the FRR’s investment policy
guidelines when managing the FRR’s assets.
FRR was the first French institutional
investor to have officially launched inJune 2005 a call for tenders to invest about€600m in an ESG-conscious manner5.
The AGIRC-ARRCO acronym designates
both the complementary pension planfor private sector employees covered by
the general old-age pensions regime6,
and the national federation (Fédération
AGIRC-ARRCO) that oversees it. Pension
institutions (institutions de retraite
complémentaire) underlying the AGIRCARRCO federation are private, nonprofit entities established by collective
agreement with the aim of implementing
the AGIRC-ARRCO plan, under thesupervision and coordination of the
AGIRC-ARRCO federation. The federationand pension institution members (theAGIRC-ARRCO Pension Institutions) must
operate the AGIRC-ARRCO pension plan
within a framework, which is agreed
through a collective bargaining process
between employers’ and employees’
representatives. The latest version ofthis framework agreement is dated
17 November 2017 (the AGIRC-ARRCO
framework agreement)7.
The AGIRC-ARRCO federation and
AGIRC-ARRCO Pension Institutions are
responsible for the management of theassets of the AGIRC-ARRCO plan. They
must do so in accordance with the AGIRCARRCO framework agreement as well as

Occupational pension plans
2.2.9

The French pension system also consistsof the retraite professionnelle supplémentairesystem, which is based on occupational
pension plans (plans d’épargne retraite).
The French occupational pension
plans framework, which used to covera large number of different products
each governed by specific eligibility
requirements, tax regimes and operating
rules, was streamlined in 2019 by the
PACTE law9. Under the current regime,
all occupational pension plans (plansd’épargne retraite – PER) are governed bya harmonised regime set forth in articles
L. 224-1 et seq. of the French Monetary and
Financial Code (Code monétaire et financier –FMFC), which covers the following three
types of PER plans:• ‘collective’ PER (plan d’épargne retraite

d’entreprise collectif – PERcol), which areemployer-sponsored plans, in which
employees participate on a voluntary basis10;• ‘mandatory’ PER (plan d’épargne retraite

d’entreprise obligatoire – PERcat), which areemployer-sponsored plans, in which all
employees (or certain defined categories of
employees) are required to participate11; and• ‘individual’ PER (plan d’épargne retraite

individual – PERin), which are voluntaryindividual plans12.
2.2.10 Individual PER plans (PERin) can take theform of either an insurance product ora securities account where the relevant
assets are recorded. PERin taking the formof a securities account are operated by theentity that maintains the account (eithera credit institution or investment firm).
PERin taking the form of an insurance
product are operated by an insurance
undertaking or a supplementary
professional pension fund (fonds de retraite
professionnel supplémentaire – FRPS13).
Collective PER plans (PERcol and PERcat)
are operated by insurance undertakings
or FRPS14. The individual (in the caseof PERin) or the operator of the PER
plan (PER Operator) may delegate theinvestment management of the PER plan
to investment manager(s).
2.2.11 FRPS were created in 2017 by Ordinance2017-48415 and are the only French entities
that are institutions for occupational
retirement provision (IORPs) within themeaning of Directive (EU) 2016/2341 (IORP
II)16. As of 1 May 2020, there were five FRPS
in France17 as most occupational pension
plans remain operated by insurance
undertakings or investment managers.
2.2.12 In principle, a PER plan is managed by the
PER Operator (or investment manager(s)appointed by the PER Operator or, for PERin
taking the form of a securities account,the saver). However, the relevant employee
or saver may opt to make their own
investment decisions within the PER plan.
2.2.13 The main entities/groups of persons
involved are:ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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GLOSSARY
REFERENCES• Asset Owner: for basic and complementary

pension plans, the relevant pension plan.
Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCECONTENTSFOREWORDSINTRODUCTION

For PER plans, the saver for PERin taking
the form of a securities account or the PER
Operator for PER plans taking the form of
an insurance product.
• Beneficiaries: for basic andcomplementary pension plans, therelevant individuals and, arguably
the French nation at large (since thepurposes of those plans is to manage theFrench pension resources to ensure theirlong-term financial sustainability). For
PER plans, the relevant individuals. For
collective PER plans (PERcol and PERcat),
employers might be considered as afurther group of Beneficiaries due to theirposition as sponsor of the plans.
• Investment decision-maker: For basic

and complementary pension plans, theplan operator or investment manager(s)appointed by the operator. For PER
plans, the PER Operator or investment
manager(s) appointed by the PER Operator
or, in the case of PERin taking the formof a securities account, relevant savers orinvestment managers appointed by them.
Where the relevant individual has opted
to make their own investment decisions,such individual.
Overview of investment duties and powers
AGIRC-ARRCO
2.2.14 The AGIRC-ARRCO plan is ‘contractual’(conventionnel) in nature, inasmuch as it
is a product of a collective bargaining
agreement between employees’ andemployers’ representatives. Therefore,
the French statutory and regulatory
provisions applicable to the plan, the
AGIRC-ARRCO federation and the AGIRCARRCO Pension Institutions do not include
specific provisions regarding investment
duties and powers of the AGIRC-ARRCO
federation and AGIRC-ARRCO Pension
314

Institutions (which are responsible for the
management of the plan’s assets).
2.2.15 Unlike the basic pension plans, which
can receive additional payments fromthe French state or certain employers tocover any shortfall in financial resources,
the AGIRC-ARRCO plan is required to be
self-sustainable (ie it can neither receive
any such payments nor incur debt).
The plan’s primary aim is therefore toensure that it holds sufficient financial
reserves to be able to meet future
payment obligations to Beneficiaries. In
this respect, the preamble of the AGIRCARRCO framework agreement and theregulation of the AGIRC-ARRCO federation
provides that the plan’s financial reserves
must be ‘managed in a socially responsible
manner while complying with the expected
profitability, security, liquidity andperformance needs’18.
2.2.16 On that basis, Title II of the AGIRCARRCO financial guidelines lists the typesof assets in which the plan can makeinvestments, and sets forth investment
rules and limits to manage the plan’s risk
exposure19. The plan’s assets must also
be invested in accordance with the asset
liability management policy, risk limits
and asset allocation policy approved by
the board of the AGIRC-ARRCO federation.
The AGIRC-ARRCO Pension Institutions
must define their asset allocation andmore generally investment policy on thebasis of such principles20.
2.2.17 The AGIRC-ARRCO financial guidelines
also state that, in light of the principles
applicable to the financial managementof the plan as set forth in the preamble of
the AGIRC-ARRCO framework agreement,
the AGIRC-ARRCO Pension Institutions
and federation ‘must make investments

taking account of environmental, socialand quality of governance criteria’21.
ESG criteria are further embedded in thecontractual arrangements underlying the
AGIRC-ARRCO plan and the federation’sand Pension Institutions’ investment
guidelines. Indeed, both the preamble of
the AGIRC-ARRCO framework agreement
and the regulation of the AGIRC-ARRCO
federation state that ‘environmental,social and good governance impacts must
be taken into account in the framework of
the plan’s investment policy’.
FRR
2.2.18 FRR does not directly manage its portfolio
since its assets are managed by investment
managers it appoints from time to time
(which are required to comply with the
FRR’s investment policy guidelines whenmanaging the FRR’s assets). Therefore,
the French statutory and regulatory
provisions applicable to the FRR do notinclude specific provisions regarding
investment duties and powers of the FRR.
However, the investment managers thatare appointed to manage the FRR’s assets
must comply with the FRR’s statutory andregulatory regime, which can generally bedescribed as follows.
• Prudent management. Under article

L. 135-6 of the French Social Security
Code (Code de la sécurité sociale – SSC), FRR’s
main purpose is to ‘manage the sums
entrusted to it with a view to building
financial reserves aimed at contributing to
the financial sustainability of the pension
system’. On that basis, the FRR investment
policy guidelines must be consistent
with ‘the principles of prudence and risk
spreading, taking account of the defined
timeframe for utilisation of the Fund’s
resources’22. This means that the principal

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
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objective of the FRR’s investment strategy
is to manage its assets in a manner thatwill ensure that it can meet the payment
obligations set down by French law23 and,then, to seek the best possible return on
its investments.
• Characteristics of the portfolio. To

ensure that the FRR’s investments areappropriately prudent, its assets must be
invested in accordance with investment
rules and limits that are set forth by the
French government24. In addition, the FRR’s
investment policy is based on principles
regarding the investment horizon anddiversification of its portfolio, as well as arobust risk-management framework.
PER (Plan épargne Retraite)
2.2.19 PER plans are investment plans rather
than legal entities. Therefore, PER plans
are not subject to any investment duties
or powers, which rather bind the PER
Operators. However, PER plans are subject
to investment rules and limits, which PER
Operators (or their delegate investment
managers) must comply with when
operating a PER plan.
2.2.20 Firstly, under French law, the purpose ofa PER plan is to invest the plan’s assets
to provide the Beneficiary, upon theirretirement, with a personal annuities
entitlement or right to receive a lumpsum to cover their pension needs25. To
achieve this purpose, PER plans must be
invested in a limited list of assets thatoffer sufficient financial protection26.
Unless the Beneficiary has opted to maketheir own investment decisions, PER plans
must be managed to minimise over time
the financial risk associated with theplan’s assets (ie as the Beneficiary nears
retirement, the PER Operator is required
to invest in progressively less risky assets).
315

The primary aim of a PER plan is therefore
to ensure financial security and goodpensions for the Beneficiaries in retirement.
Therefore, in general, the Beneficiaries’interest is served where the investment
achieves financial return consistent withthe respective investment objectives.
2.2.21 The PER plans regime requires that
Beneficiaries be offered the possibility
to select at least one alternative asset
allocation, including notably, for PERcol
and PERcat27, an allocation allowing themto invest in social impact funds (fonds
solidaires) that invest in specific social
impact companies (entreprises solidairesd’utilité sociale), as defined under article
L. 3332-17-1 of the French Labour Code
(Code du travail)28. Social impact companies
do not directly include companies meeting
ESG or sustainability criteria29. In any event,any such alternative asset allocation mustremain such that it allows the PER plan toprocure appropriate retirement benefits.
PER Operators – FRPS
2.2.22 Typically, the investment duties of FRPS
are determined by (i) the contractual
terms of the relevant PER plan andunderlying insurance product (whichmust be consistent with the PER plan’srules mentioned in sections 2.2.20 and
2.2.21), and (ii) the French-law regime
applicable to FRPS.
2.2.23 The main legal duties and powers under
the French FRPS regime can generally bedescribed as follows.
(a) Prudent person principle. FRPS must
invest in accordance with the ‘prudent
person’ principle (PPP)30. This requires, inparticular, that assets be invested in thebest long-term interest of Beneficiaries asa whole31.

(b) Governance. FRPS must have in place
an effective system of governance,
which provides for sound and prudent
management of their activities and is
proportionate to the size, nature andcomplexity of the activities of the FRPS32.
Such a system shall include considerationof ESG factors related to investment assets
in investment decisions33.
(c) Risk management and risk assessment.
FRPS must maintain an effectiverisk-management system, which is
proportionate to their size and internalorganisation, as well as to the size, nature,scale and complexity of their activities
and which shall cover, among otherthings, the areas of investment, liquidity
and concentration risk management
as well as ESG risks relating to theinvestment portfolio and the management
thereof and ESG-related risks facing
Beneficiaries34. Further, FRPS mustcarry out and document their own-risk
assessment35. Where ESG factors are
considered in investment decisions, article
R. 385-16-1 of the French Insurance Code
(Code des assurances) expressly requiresthat the risk assessment needs to include
an assessment of new or emerging risks,
including risks related to climate change,
use of resources and the ESG risks andrisks related to the depreciation of assets
due to regulatory change.
(d) Reporting requirements. FRPS are required
to include in their annual report and keep
available to Beneficiaries information on
how they incorporate ESG criteria into theirinvestment policy, the type of ESG criteria
taken into account and how they exercise
voting rights attaching to investments
taking account of their ESG choices36.
Reporting requirements cover ESG-related

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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information on (i) how FRPS integrate ESG
criteria in their investment policy (Investor
ESG Information), and (ii) the FRPS’s
investments (Investment ESG Information)37.

that the plan’s financial reserves mustbe ‘managed in a socially responsible
manner’, it also immediately qualifies
this statement by adding that the plan’sreserves must be so managed ‘while
complying with the expected profitability,
security, liquidity and performance needs’
and that ‘environmental, social and good
governance impacts must be taken into
account in the framework of the plan’sinvestment policy’41. The drafting of theregulation of the AGIRC-ARRCO federationsuggests that the requirement to manage
reserves in a socially responsible manner.
However, the primary aim of the plans
remains which is to generate sufficientfinancial return. This is however notinconsistent with instrumental IFSI,
inasmuch as if ESG factors are determined
to pose a risk to the achievement of theinvestment return in the long term andthat IFSI is appropriate to mitigate that
risk, IFSI would then be required under the
regulation of the AGIRC-ARRCO federation.

Investment ESG Information includes
in particular extended climate changerelated reporting items, namely (i) anassessment of the FRPS’s portfolio’s
exposure to climate change-related risks,
including both physical risks (physicalimpact of climate change) and transition
risks (impact of the transition to a lowcarbon economy); and (ii) an assessmentof the FRPS’s contribution to meeting theinternational and national low-carbon
goals, including the tentative low-carbon
targets set by the FRPS itself and theactions taken to achieve these targets38.
Where they invest, either directly or
through investment managers, in shares
listed on a regulated market, FRPS mustalso make available on their website how
the main elements of their investment
policy are consistent with the profileand duration of their liabilities, inparticular long-term liabilities, and how
they contribute to the medium-to-longterm performance of their assets39. The
information disclosed must be updated
at least annually and following any
substantial change40.
Legal requirements to use investment powers to
pursue IFSIAGIRC-ARRCO
2.2.24 The French statutory and regulatory
regime applicable to the AGIRC-ARRCO
plan does generally not provide for ageneral obligation of the AGIRC-ARRCO
federation or Pension Institutions to
use their investment powers to pursue
IFSI. Even though the regulation of
the AGIRC-ARRCO federation states
316

FRR
2.2.25 Under French law, the FRR is, as a
general principle, not expressly obliged
to use investment powers to pursue
IFSI. The only reference to sustainable
investment in the statutory and regulatory
regime applicable to the FRR is that theexecutive board (directoire) of the FRR
must regularly report to its supervisoryboard (conseil de surveillance) on how the
FRR’s investment policy guidelines havetaken into account ESG considerations.
This creates a ‘procedural’ obligation tomaintain investment guidelines that takeaccount of ESG considerations, but does
not create any requirement that the FRR’s
assets should be invested for sustainability
impact. However, the requirements that

FRR be managed in a prudent way (seesection 2.2.18(a)) suggest that instrumental
IFSI is required where the FRR determinesthat ESG factors jeopardise its ability tomeet the payment obligations set down
by French law42 and seek the best possible
return on its investments
2.2.26 The FRR is also in a unique situation
among the institutions within the French
pension system. Under French law, the
FRR investment policy guidelines must be
consistent with ‘the principles of prudence
and risk spreading, taking account of thedefined timeframe for utilisation of the Fund’s
resources’43. Facing a defined investment
horizon and pay-outs expectations rather
than a general, undefined ‘long-term’financial return goal, the FRR has had
more leeway to consider IFSI than otherinvestors within the French pension
system. Actually, although the FRR isunder no explicit statutory or regulatory
requirement to pursue IFSI, it has longtaken the stance to voluntarily takeaccount of ESG criteria in its investment
decisions, as further discussed in sections
2.2.32 et seq.44
PER operators – FRPS
2.2.27 Under French law, FRPS are, as a generalprinciple, not expressly obliged to use
investment powers to pursue IFSI.
Consistent with the primary aim of PERplans, which is to ensure financial security
and good pensions for the Beneficiaries
in retirement, the Beneficiaries’ interestis served where the investment achieves
financial return consistent with that
objective. There might be certain
situations giving rise to a duty to invest
with a view to sustainability impact, inparticular where ESG or sustainability
factors are to be considered financially

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B. THE EXTENT TO WHICH
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BrazilCanadaChina

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material and IFSI is perceived as mitigating
their impact. Indeed, ESG risks may
trigger, or transform into, financial risks
and be therefore financially material
regarding the performance of a portfolio.
In this case, it might be ‘prudent’ in the
traditional sense to take such risks into
account as part of the PPP.
2.2.28 It is unclear under French law
whether the ‘best interest’ of PER plan
Beneficiaries should be limited to financial
factors or could also include non-financial
factors. It could theoretically be argued
that the Beneficiaries’ ‘best interest’ may
comprise non-financial aspects such as
the wellbeing or health of Beneficiaries.
On this basis, one could suggest that FRPS
might be obliged to consider sustainability
impact for Beneficiaries even in cases
where their (future) financial interests
are not affected. However, PEP plans
first and foremost remain ‘investment
plans’, the purpose of which is to coverpart of the Beneficiaries’ financial needs
in retirement. This may suggest thatthe Beneficiaries’ ‘best interest’ should
primarily be regarded as met where theinvestment secures their (future) financial
entitlements. For the same reason, it
is unclear whether FRPS could, undercertain circumstances, be required to seek
to ensure wider societal objectives. On
the contrary, PER plans must be managed
to minimise over time the financial risk
associated with the plan’s assets (ie as
the Beneficiary nears retirement, the
PER Operator is required to invest in
progressively less risky assets). This showsthat the need to ensure financial security
and seek financial return should takeprecedence over non-financial factors
when managing a PER plan.
317

Legal freedom to use investment powers to
pursue IFSIAGIRC-ARRCO
2.2.29 Both the preamble of the AGIRC-ARRCO
framework agreement and the regulationof the AGIRC-ARRCO federation state thatthe plan’s reserves must be managed ‘ina socially responsible manner’ and that‘environmental, social and good governanceimpacts must be taken into account in theframework of the plan’s investment policy’.
The contractual framework that governs
the AGIRC-ARRCO plan therefore explicitly
gives the federation the possibility to reflect
ESG criteria in the plan’s investment policy
and, more generally, gives the federation
and Pension Institutions flexibility for
IFSI. These general principles actually go
beyond the mere procedural requirement
to ‘take ESG criteria into account’ by
explicitly stating that the plan’s reserves
must be managed ‘in a socially responsible
manner’45. Even though this explicit
requirement remains subject to the plan’sfinancial sustainability (as further discussed
below), it does create a requirement thatgives the AGIRC-ARRCO federation andPension Institutions more leeway, in ourview, to pursue IFSI. In September 2019,
the AGIRC-ARRCO federation signed the
UN-sponsored Principles for Responsible
Investment (UNPRI).
2.2.30 This freedom is subject to the overarchingrequirement that investing the plan’sassets must meet its expected profitability,
security, liquidity and performance needs.
That being said, this obligation to seek
profitability and financial performancedoes not comprise the prescriptionof a particular level of return to beachieved. The typical duration of theplan’s liabilities also implies a long-term

nature of its investments. Consistent
with the nature of the plan as a pay-asyou-go pension system, which relies oninterprofessional and intergenerational
solidarity46, the principle of meeting the
expected financial return of the AGIRCARRCO plan should, at least, require along-term, rather than a short-to-mediumterm perspective. As sustainability
risks are more likely to materialise in
the long-term, this arguably provides
AGIRC-ARRCO Pension Institutions withadditional grounds to take account ofsustainability criteria.
2.2.31 Moreover, unlike many pension
institutions in other countries, the
AGIRC-ARRCO federation and Pension
Institutions do not have any specificdirect duties to individuals that are
Beneficiaries of the plan. They therefore
are not required to assess whether theirinvestment decisions conflict with the
Beneficiaries’ interest, but rather only
make sure that overall, the integrationof sustainability impact in investment
decisions is not inconsistent withmeeting the plan’s portfolio’s financial
return and does not endanger the plan’sfinancial sustainability. This removes any
possible perceived increased liability risk
associated with investment decisions that
could be construed as not being madein the ‘best’ interest of Beneficiaries.
There is also in our view clearer potentialalignment between IFSI and a plan thathas to foster long-term ‘interprofessional
and intergenerational solidarity’,rather than a plan that has to assess its
investment decisions directly in light ofspecific Beneficiaries’ best interest. Thismight allow for some freedom in thespecific shaping of the plan’s investments,
including seeking to ensure wider societal

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B. THE EXTENT TO WHICH
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objectives that are beneficial to society
on an intergenerational basis, and permit
a degree of ultimate ends IFSI as long as
it is not inconsistent with the expectedlong-term financial return of the portfolio
as a whole.
FRR
2.2.32 The statutory and regulatory rules
applicable to the FRR are flexible enoughto allow for IFSI, and FRR has long taken
advantage of this flexibility to encourage
or even require that investment managers
take account of ESG criteria whenmanaging its portfolio.
2.2.33 As for the AGIRC-ARRCO federation
and Pension Institutions, the FRR does
not have any specific direct duties toindividual Beneficiaries (see section
2.2.31). The investment managers thatmanage its assets therefore do not haveto assess such Beneficiaries’ best interest
when making investment decisions.
They rather have to ensure that theirinvestment decisions are made in thebest long-term interest of the FRR itself,
and in accordance with the investment
management agreements they haveentered with the FRR (which reflect the
FRR’s investment policy). In 2003, the
FRR supervisory board emphasised that
the FRR’s ‘investment policy should
be consistent with respecting certain
collective values that encourage balanced
economic, social and environmental
development […]’. This typifies thepeculiarity of the FRR as comparedto those institutional investors thathave explicit duties to the individual
Beneficiaries. On the contrary, theinvestment managers that manage the
FRR’s portfolio are only required to take
into account the FRR’s interest, as defined318

in its investment policy guidelines47 andresponsible investment strategy. In thisrespect, the FRR considers that as a public
investor and ‘vector for intergenerational
solidarity’48, it must factor ESG principles
in the investment management of
its assets. In other words, the FRR’s
interest encompasses factors that are notexclusively financial criteria.
2.2.34 On this basis, the supervisory board andexecutive board of the FRR have earlyon adopted a three-pronged strategy topromote ESG investment and best practicecorporate governance:• an active policy of proxy voting atshareholders’ meetings of companies inwhich the FRR invests;• the broadening of stock researchand picking criteria to include ESG
considerations by investment managers
selected to manage the FRR’s portfolio; and• launching a number of dedicated ESG

mandates, with the aim of gaining a bettergrasp of the ESG-inclusive analysis thatcan be implemented and the value added
by ESG criteria49.
Since April 2006, the FRR has also committed
to applying the UN-sponsored Principles for
Responsible Investment (UNPRI).
2.2.35 According to the FRR, its main mission is‘to optimise returns on the funds entrusted
to it, on behalf of the community, in as
secure an environment as possible’50.
Because ESG factors can have an impact oncompany valuations and therefore on the
returns of the FRR’s portfolio, the FRR has
noted that failure to integrate these factors
into its decision-making process could be
detrimental to achieving its objective51. In
addition, the FRR has also stated that it
must take account of non-financial factors

because ‘investment yields do not depend
solely on the impact of companies’ financial
and non-financial strategies, but also on
the externalities they generate for theirindustry or the economy as a whole.’52 FRR
draws the conclusion therefrom that, as ‘auniversal public investor, active in pensions,whose role it is to protect its investments
over the long term’, it must ‘analyse theenvironmental and social externalities
of corporate strategies and their effects
on the community’. In other words, thefundamental rationale underlying the FRR’s
Responsible Investment Strategy is that itshould take account of systemic risk andnon-financial factors.
2.2.36 The framework within which the FRR
operates not only fosters taking accountof ESG criteria when making investment
decisions, but also allows for IFSI. In
its 2013-2017 Responsible Investment
Strategy, the FRR expressly stated that,as part of ‘a new approach for the FRR’, it‘shall also help to finance companies thecorporate mission of which is to preserve
the environment or are beneficial tosociety’53. FRR has also implemented an
exclusion policy regarding companies
involved in the development, production,
maintenance, use, distribution,
stockpiling, transport or trade of banned
weapons or their key components and thetobacco industry54. Finally, the FRR has
implemented an ambitious policy aimed
at reducing its portfolio’s CO2 emissions
through low carbon management55. In
2018, the FRR decided to further exclude
companies whose thermal coal miningor coal-fired electricity, heat or steam
generation business exceeds 10 per
cent of their revenue, unless they use acarbon capture and storage process or theinvestment manager invests on behalf of

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B. THE EXTENT TO WHICH
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the FRR with the aim of supporting therelevant company transitioning to a new
production model. The call for tenders
launched by the FRR in 2015, entitled‘Optimized Equity index strategy withan ESG approach’ aimed at awarding
mandates to Investment Managers, which
require that they factor in all types of
ESG-related matters ( including thoserelating to decarbonising assets), as wellas the FRR’s exclusion policy. These steps
taken by the FRR show that it is generally
allowed to invest for sustainability impact
and also engage in ultimate ends IFSI.
2.2.37 The flexible framework applicable to
the FRR does not mean that it is free
to unlimitedly prioritise sustainability
goals over financial goals.. Its investment
managers are still required to deliver
expected financial performance. In
2009, the FRR announced that it had
terminated an ESG mandate because ofits ‘poor relative financial performance’56.
Nonetheless, in our view, the FRR has
more flexibility than most institutional
investors to balance non-financial
factors and financial ones. First because,
as discussed above, (i) it has no direct
duty, as a matter of statutory or
regulatory requirement, to individual
Beneficiaries, and (ii) its stated main
mission encompasses not only the pension
system’s financing but also a mandate
to manage the funds entrusted to it ‘onbehalf of the community, [and] in as
secure an environment as possible’57. In
addition, French law sets out a defined
timeframe for the pay-outs of the FRR’s
assets58. Its primary financial objectiveis therefore to be in a position to deliver
the required pay-outs, but not, strictly
speaking, to achieve the best possible
financial performance for its portfolio.
319This might provide the FRR with moreleeway to take into account ESG criteria
and engage in ultimate ends IFSI, even incases where it could potentially affect tosome extent the financial performance of
certain of its investments. Faced with thisconstraint, the latest version of the FRR’s
Responsible Investment Strategy, covering
the period from 2019 through 2023,
states that the FRR ‘might give further
thought to the valuation of non-financial
performance and on how the utility of its
investments’ impact should be added totheir financial performance’59.
PER Operators – FRPS
2.2.38 We consider that the duties of FRPS are,in our view, flexible enough to allow for
IFSI, subject to the PPP as an underlying
principle (see section 2.2.23(a)). Therefore,
the integration of sustainability impact
in investment decisions must not conflictwith the Beneficiaries’ ‘best interest’. In
particular, it should not negatively affect theinvestment’s financial return and security
and endanger the Beneficiaries’ (future)
financial entitlements. Where a conflictarises between sustainability impact andfinancial return, the investment would
rather need to be made in favour of the(financial) ‘best interest’ of the Beneficiaries.
In our view, this does not amount to an
obligation to seek either the maximum
rate of financial return or a particularlevel of return (subject to any contractual
undertaking to Beneficiaries). However, as
the relevant Beneficiaries near retirement,
PER plans’ outlook converts from a longterm perspective to a medium- or evenshort-term perspective, which decreases any
ability to invest for sustainability impact if it
does not align with an expected appropriate
level of financial return.

2.2.39 Unlike the AGIRC-ARRCO federation
and Pension Institutions and the FRR,FRPS have direct duties to PER plan’Beneficiaries. In our view, this might
result in FPRS being reluctant to makeuse of their investment freedom to pursue
IFSI, due to legal uncertainties which
exist with regard to the characterisationof the Beneficiaries’ ‘best interest’ andits interaction with IFSI. This might,
from time to time, be perceived asincreased liability risk. Similarly, there
is generally no explicit obligation for
FRPS to align investments with thesustainability preferences of Beneficiaries.
However, French law applicable to FRPS
expressly allows them to take accountof Beneficiaries’ preferences inasmuch
as Beneficiaries must be offered thepossibility to select at least one alternative
asset allocation, including notably, for
PERcol and PERcat, an allocation allowing
them to invest in social impact funds(fonds solidaires) that invest in specificsocial impact companies (entreprises
solidaires d’utilité sociale)60. Social impact
companies do not directly include
companies meeting ESG or sustainability
criteria61 but this regime alleviates any
perceived liability risk for FRPS.
2.2.40 Finally, the French ESG reporting regime62
encourages FRPS to incorporate ESG
criteria into their investment policy andassess how they manage and vote theirportfolio taking account of their ESG
choices. The ESG reporting regime provides
institutional investors with broad flexibility
in choosing the best way to fulfil theobjectives, based on a ‘comply or explain’
approach. It does not impose any specificmethod, giving leeway to find the reporting
methodology best suiting the investment
portfolio. However, investors must provide

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B. THE EXTENT TO WHICH
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information and justification on themethodology used and are encouraged
to draw from current best practices.
Introducing such detailed reporting
requirements, which apply to most French
institutional investors, has certainly
proven to be a catalyst for such investors
to actually take account of ESG criteria intheir investment decisions. Even though
the reporting regime does not create
any statutory or regulatory obligation to
IFSI, it has underscored that French law
clearly encourages French institutional
investors to invest in an ESG-conscious
manner, including, as the case may be, IFSI.
Similarly, since FRPS must make public
how the main elements of their investment
policy regarding shares are consistent withthe profile and duration of their liabilities,
in particular long-term liabilities, and how
they contribute to the medium-to-longterm performance of their assets 63, FRPS
should factor those constraints into theirrelevant investment policy.
2.3

Mutual funds

as Organismes de Placement Collectif en Valeurs
Mobilières (OPCVMs).
• French mutual funds that are establishedas alternative investment funds, within
the meaning of the Alternative Investment
Fund Managers Directive (Directive
2011/61/EU on Alternative Investment
Fund Managers (AIFM)65, which arereferred to as Fonds d’Investissement
Alternatifs (FIAs).
2.3.2

2.3.3

Types of mutual fund covered
2.3.1

A mutual fund is a scheme that pools andinvests money from investors that are
intended to be retail investors. Consistent
with the applicable EU regulatory
framework, there are two main typesof French mutual funds authorised by
the French regulator Autorité des marchés
financiers (AMF):• French mutual funds that comply with thedirective on undertakings for collective
investments in transferable securities(Directive 2009/65/EC on the coordinationof laws, regulations and administrative
provisions relating to undertakings forcollective investment in transferable
securities (UCITS)64, which are referred to320

the FCP are contractual co-owners whopurchase units (parts) in the FCP and arereferred to as unit-holders (porteurs de parts).

2.3.4

The most common form of AMFauthorised mutual fund is one thatcomplies with the UCITS Directive.
On the other hand, FIAs can assume avariety of different forms, each governedby a specific set of rules under French
legislation66. Most FIAs invest in a
broad range of assets going beyond theasset types covered by this annex andare typically targeted at professional
investors. Because of that, this annex
considers only UCITS-compliant mutual
funds, ie OPCVMs

2.3.5

2.3.6

In France, OPCVMs can either beconstituted as (i) investment companies
with variable capital, known as sociétésd’investissement à capital variable (SICAVs)or (ii) contractual funds, known as fonds
communs de placement (FCPs). In both cases,
OPCVMs must be open-ended investment
schemes, meaning that investors can freely
redeem their investment in the fund67.
FCPs are entities without legal personality
and are the most common form of OPCVM
in France. An FCP is defined by French law
as a co-ownership of financial instruments
and deposits68. An FCP must be operated
by a management company69, which isauthorised by the AMF to provide fundmanagement services. An FCP must be
operated in accordance with its bylaws(règlement) and its prospectus. Investors in

2.3.7

SICAVs are companies with legal
personality, which must be established
as French companies limited by shares(either as a société anonyme or as a société paractions simplifiée)70. Although SICAVs may
be self-managed, the majority71 delegate
their operation and the administration of
their assets to a management company72,
which is authorised by the AMF to provide
fund management services. A SICAV must
be operated in accordance with its articles
of association (statuts) and its prospectus.
Investors in the SICAV purchase shares(actions) in the SICAV and are referred to asshareholders (actionnaires).
Regardless of the way an OPCVM isconstituted, its assets must be entrusted toa depositary (dépositaire) for safe-keeping.
This function is legally separated, whichmeans that a company is prohibited fromacting as a depositary and as managementcompany or investment company atthe same time73. That is because, in
addition to being responsible for thesafekeeping of the property of the fund,the depositary has certain oversightfunctions in relation to the activitiesof the management company74. When
carrying out its functions, the depositary
must act independently and solely in theinterest of the fund’s investors75. However,depositaries are not involved in the actual
taking of investment decisions, including
those comprising IFSI, and are not theowners of the fund’s assets. Depositaries
are therefore not covered in this annex.

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In this annex, OPCVMs constituted as FCPs
are considered as Asset Owners, acting
through their management company. For
Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCECONTENTSFOREWORDSINTRODUCTIONSICAVs we consider the SICAVs, acting
through their management company, if
applicable, as the relevant Asset Owner.
However, it is legally permitted andcommon in practice, that managementcompanies delegate investment
management to asset managers. Theseasset managers will be considered as
investment managers in this annex.
However, a delegation will not release
the delegating entity from its obligations.
Thus, management companies (andself-managed SICAVs, if applicable) mustmonitor and supervise the complianceof investment managers with applicable
French regulation in order to remaincompliant themselves.
2.3.8

For OPCVMs constituted as FCPs, the key
parties are:
• Asset Owner: FCP (including themanagement company).
• Investment Manager: asset manager (ifthe investment management is delegated).
• Beneficiary: unit-holder.

2.3.9

For OPCVMs constituted as SICAVs, thekey parties are:
• Asset Owner: SICAV, ie theinvestment company (including themanagement company).
• Investment Manager: asset manager (ifthe investment management is delegated).
• Beneficiary: shareholder.

Overview of investment duties and powers
2.3.10 The management company’s duties
and powers are shaped by the OPCVM
constitutional documents and prospectus,
particularly the investment objectives
and policies, which are determined by the
manufacturer when the OPCVM is set up,
as well as the relevant provisions of the321

FMFC76 and General Regulation of the AMF(Règlement général de l’AMF – GRAMF) 77.
2.3.11 An OPCVM must be operated, andits assets managed, for the benefitof its Beneficiaries. For this reason, amanagement company is, among otherthings, required:• to act honestly, fairly, professionally andindependently and solely in the interestsof the OPCVM and its Beneficiaries andthe integrity of the market78; and• to act with due skill, care and diligence,in the best interests of the OPCVM it
manages and the integrity of the market79.
2.3.12 Article 321-101 GRAMF specifies the ‘best
interest’ rule by requiring, among otherthings, that the Beneficiaries be treatedfairly by the management company andthat management companies must refrainfrom placing the interests of any groupof Beneficiaries above the interests of any
other group of Beneficiaries. OPCVMs are
established for the general purpose ofgenerating financial return. Traditionally,
it is therefore considered that the ‘best
interest’ of OPCVMs is served where thefinancial return is maximised in line with
the investment objectives of the relevant
OPCVM. In addition, managementcompanies are required to use fair, correct
and transparent pricing models andvaluation systems for the OPCVM they
manage, and must act in such a way as toprevent undue costs being charged to the
OPCVM and its Beneficiaries 80.
2.3.13 AMF rules and guidance81 haveacknowledged since 2007 the possibility
to use non-financial criteria in the processof selecting financial instruments forinvestment by French funds82. In addition,other AMF guidance has long provided fordisclosure requirements associated withsocially responsible funds (referred to as‘fonds ISR’).
• Where non-financial criteria are usedin the process of selecting financial
instruments for investment by OPCVMs,
such criteria must be briefly describedin the fund’s key investor information
document (KIID)83.
• The legal documentation of a socially

responsible fund (ie its prospectus
and constitutive documents) should (i)include an investment objective thatreflects the non-financial aspects of thefund’s investment management; (ii) state
which socially responsible investment
method(s) are implemented for the fund;and (iii) include information regarding
the selection and management methods
implemented for the fund84.
• Funds that communicate in respectof their objectives in terms of ESG
impact should (i) use clear, precise andsubstantiated and measurable objectives;and (ii) monitor over time how theseobjectives are achieved85.
2.3.14 Finally, article 77 (29) of the PACTE law86
passed in spring 2019 defined a new
specific mission for the AMF, making
it responsible for ensuring the qualityof information provided by Investment
Managers on their investment strategy
and their management of risks related
to the effects of climate change87. On
this basis, on 11 March 2020, the AMF
consolidated and expanded its guidanceon disclosure requirements for socially
responsible funds through the publicationof Position-Recommendation 2020-03 –Information to be provided by collective
investment schemes incorporating nonfinancial approaches (AMF ESG disclosure
guidelines)88. The AMF ESG disclosure

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guidelines detail a series of AMF policy
positions and recommendations forinvestor disclosures by French funds
as well as foreign funds, which areauthorised or registered for marketingin France and incorporate non-financial
objectives (eg SRI, ESG integration,
responsible, sustainable, green, ethical,
social, impact, low carbon).
2.3.15 In terms of reporting requirements,
French management companies are
subject to the same French ESG reporting
regime as FRPS (see section 2.2.23(d)).
They are required to report to the
Beneficiaries of in each OPCVM they
manage how they incorporate ESG criteria
into their investment policy, the type of
ESG criteria taken into account and how
they exercise voting rights attaching toinvestments taking account of their ESG
choices89. Investor ESG Information90 must
be provided by all French managementcompanies on their website. Investment
ESG information91 must be provided in
respect of each fund French managementcompanies manage, the AuM of which
exceeds €500m. It must be provided on
the management company’s website andin each fund’s annual report92.
(a) Investor ESG Information covers thefollowing items:• general approach to incorporating ESG

criteria into investment and, whereapplicable, risk management policies;• content, frequency and means used to

inform Beneficiaries;• list of funds for which ESG criteria aretaken into account and the proportion,
as a percentage, of the assets of thesefunds compared to the total AuM of the
management company;
322• adherence of the management company

and/or the funds to charters, codes,
initiatives and labels relating to theincorporation of ESG criteria; and• where applicable, a description of ESG

risks, the business’s exposure to theserisks and the internal procedures used to
identify and manage them.
(b) Investment ESG Information covers thefollowing items:• description of the type of ESG criteria

taken into account;• information used for the analysis

conducted on ESG criteria;• methodology and results of this analysis; and• description of the way in which the resultsof the analysis are integrated into theinvestment policy of the relevant funds:(i) changes made to the portfolios, and (ii)engagement strategy with issuers.
(c) Investment ESG Information also includes
extended climate change-related reporting
items, as further outlined in section
2.2.23(d).
Legal requirements to use investment powers to
pursue IFSI
2.3.16 French law currently does not provide for
explicit rules on whether non-financial
objectives, such as IFSI, must be taken
into account as a part of managementcompanies’ due diligence process (as a‘procedural rule’) or as part of the decisions
to make investments (as a ‘substantive
rule’). Therefore, OPCVMs and/or their
management companies are not subject toany explicit general duty to pursue IFSI.
2.3.17 The main rule that applies to fundmanagement activities is that funds(including OPCVMs) must be managed in
the best interest of the relevant fund andits Beneficiaries 93. There is no definitionin French law or AMF’s guidance of what
the concept of ‘best interest’ is meant tocover. Such ‘best interest’ is traditionally
understood as primarily a duty to pursue
financial return. This traditional viewof the purpose of collective investment
schemes is supported by the definitionof alternative investment funds underthe AIFMD. In its guidelines on key
concepts of the AIFMD, the European
Securities and Markets Authority (ESMA)
notes that one of the key characteristics
of an alternative investment fund isthat it ‘pools together capital raised
from its investors for the purpose ofinvestment with a view to generating
a pooled return for those investors’94,
with ‘pooled return’ being defined as‘the return generated by the pooledrisk arising from acquiring, holding or
selling investment assets – including theactivities to optimise or increase the valueof these assets […]’95. If the sustainability
impact (or risk associated with the lackthereof) of a given investment decision
posed a risk to financial return, amanagement company should, in ourview, invest for sustainability impact ifthat may be capable of mitigating therisk (which would mean that the decision
is in the ‘financial’ best interest of the
Beneficiaries). Conversely, a managementcompany could not in our view makeinvestments that it knows are unlikely to
be financially sound (in light notably of
the relevant fund’s investment horizon),even if they are justified by a positive
sustainability impact (subject to the termsof the documentation of the relevant
OPCVM (see section 2.3.22).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

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European Union
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Netherlands

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GLOSSARY
REFERENCES

2.3.18 Notwithstanding the above, Frenchlaw does not support a purely financial
Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCECONTENTSFOREWORDSINTRODUCTION

understanding of ‘best interest’, which isalso used to assess management companies’
action in other contexts, such as for
instance conflicts of interest circumstances.
In circumstances where a potential conflict
between IFSI and financial return would
arise, we believe a management company
would have some leeway to make an
informed decision that does not necessarily
aim at only maximising financial return.
However, the management company would
have no obligation to pursue IFSI, as it
could decide to prioritise financial return
over other considerations (subject always
to the terms of the documentation of therelevant OPCVM).
2.3.19 Some French rules applicable to fundmanagement activities may arguably
hinder IFSI, inasmuch as somemanagement companies might consider
that they limit their ability to makeinvestment decisions taking account of
their sustainability impact:(a) OPCVMs are open-ended funds andtherefore subject to constantly changing
ownership. Their investment horizons
will consequently be rather short-term.
As the benefits of IFSI typically arise on alonger-term timeframe (notwithstanding
however possible short-term
implications), management companies
might consider that IFSI does not alignwith the liquidity profile and associatedtarget investors of OPCVMs.
(b) Beneficiaries of an OPCVM must be treatedfairly by the management company,
which must also refrain from placing theinterests of any group of Beneficiaries
above the interests of any other group of
Beneficiaries96. A management company
might consider that it therefore cannot
favour the interests of future Beneficiaries
323(which may be negatively affected by adecision in favour of short-term profit
at the expense of sustainability impact)
over the interests of current Beneficiaries(which would benefit from short-term
financial return). For the same reason, it
is neither permitted nor required to takediverging sustainability aspirations ofan OPCVM’s Beneficiaries into account,where they are not explicitly mentioned in
the investment policy of the OPCVM.
(c) OPCVMs must be managed so as toprevent undue costs being charged to
the OPCVM and its Beneficiaries 97. Costs
associated with pursuing investment
strategies that take the impact of theinvestment on sustainability into accountmay be considered as undue costs, if the
OPCVM’s investment policy does notinclude such target.
2.3.20 Disclosure obligations under the ESG
reporting regime98 – while themselves
not requiring the pursuit of IFSI – might‘nudge’ OPCVMs towards the same, since(potential) Beneficiaries may be interested
in IFSI99.
Legal freedom to use investment powers to pursue
IFSI
2.3.21 As noted in section 2.3.13, the AMF
expressly allows management companies of
OPCVMs to use non-financial criteria in theprocess of selecting financial instruments
for investment by French funds100. This is
an indication that, from the regulator’s
perspective, management companies may
assess the views of Beneficiaries on theirinvestment preferences and take theminto account when managing an OPCVM’s
portfolio. Similarly, article 321-120 GRAMF
provides that an OPCVM’s prospectus
may allow the sharing of the OPCVM’s
financial returns with associations serving

the public interest, through the OPCVM
making donations to such associations101.
Again, this shows that French funds law
does not prevent an OPCVM from taking
account of the views of Beneficiaries not
only on their investment preferences but
also, more broadly, on how they wish that
the OPCVM’s financial return be used.
This also suggests that the best interestof Beneficiaries does not necessarily haveto be fulfilled through such Beneficiaries
benefiting from the fund’s financial return.
2.3.22 There is therefore no reason why
Investment Managers would not be
entitled to take account of the viewsof OPCVMs’ Beneficiaries on IFSI. It isthen for Beneficiaries to find and select
OPCVMs that reflect their expectations
on IFSI. In this respect, the relationshipbetween an OPCVM and its managementcompany, on the one hand, and its
Beneficiaries, on the other hand, isprimarily contractual in nature. The
terms of this relationship are set forth in
the OPCVM’s prospectus and constitutive
documents. As long as this documentation
is clear that an OPCVM may (or will)
pursue IFSI, neither French law nor the
AMF’s guidance prevent Investment
Managers from investing in such a way on
behalf of an OPCVM. In its guidance on
OPCVMs that use non-financial criteria102
or that can share financial returns withassociations103, the AMF outlines several
conditions that Investment Managers
must meet when managing any such
OPCVMs, none of which relates to the‘best interest’ rule or duties to treat
Beneficiaries fairly or prevent undue costs(see sections 2.3.11 and 2.3.12).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

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Netherlands

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GLOSSARY
REFERENCES

2.3.23 In our view, this also allows Investment
Managers to engage in ultimate ends
Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCECONTENTSFOREWORDSINTRODUCTIONIFSI, provided this is clearly disclosed
to Beneficiaries in the OPCVM’s
documentation, although this raises
additional issues relating to the ability ofInvestment Managers to combine this typeof strategy with their traditional duties visà-vis Beneficiaries. In this respect, the AMF
has noted that impact investing strategies(or investment strategies with a tangible
objective) raise various implementation
issues, such as:• the ability of the Investment Manager toformalise criteria allowing the selectionof investee companies that actually meet
Beneficiaries’ views and expectations;• the ability of the Investment Manager toreport on whether the strategy delivers
the expected outcome (especially where
the fund’s objective or impact strategy is along-term one); and• the fact that there may be too few investee

companies that meet the stated objective
or fall within the chose impact strategy toallow the Investment Manager to offer afinancially suitable fund for Beneficiaries
that are prepared to take only moderate
financial risks104.
• The AMF suggests that this type of strategy

may be more suitable for institutional
Beneficiaries with sufficient financial
footing to invest in these strategies without
jeopardising the overall liquidity anddiversification of their portfolio105.
2.3.24 Clear information seems to be the way the
AMF considers that Investment Managers
can balance the need to manage OPCVMs
in compliance with French funds law
requirements (such as the duty to act
in the best interest of the OPCVM andits Beneficiaries) and the ability to takeaccount of Beneficiaries’ preferenceson how a given OPCVM should invest324(including for sustainability impact).
This is the philosophy underpinning the
AMF ESG disclosure guidelines that werereleased by the AMF in March 2020106:• According to the AMF, current

developments on ESG investment
management in the asset management
industry take place in a moving
framework in which various approaches,with differing degrees of ambition, may
be put forward to Beneficiaries, whichthemselves have different expectations
and needs.
• On that basis, the AMF considers that

information provided to Beneficiaries
must be accurate, clear and not
misleading so that Beneficiaries have agood understanding of the ESG approach
implemented by funds they may invest inand to manage ‘green-washing’ risks. The
AMF therefore considers that information
provided to Beneficiaries must be
proportionate to how the relevant fundactually takes account of non-financial
criteria. In particular, only those funds
that adopt an approach that corresponds
to a significant commitment should beallowed to present their use of nonfinancial criteria as a key element of theircommunication or reflect it in their name.
• Accordingly, funds that wish to present

their use of non-financial criteria as a
key element of their communication
or reflect it in their name must comply
with minimum standards, as definedin the AMF ESG disclosure guidelines.
In particular, funds must include in
their legal documentation measurable
objectives associated with their taking
account of non-financial criteria. These
measurable objectives must be significant
to ensure a real distinction between

the different approaches found on themarket. For example, as regards ‘bestin-class’ approaches, funds must use
quantitative thresholds derived fromthe French SRI label (see section 2.3.29)
as a benchmark to assess whether theircommitment is significant. For ‘selectivity’
approaches, funds must commit to aminimum reduction of 20 per cent ofissuers with the lowest ESG rating intheir investment universe. For otherapproaches, management companies must
be in position to show to the AMF how thechosen commitment is significant.
In other words, the AMF ESG disclosure
guidelines are aimed at ensuringthat Beneficiaries (in particular retail
Beneficiaries) are provided withinformation that allow them to assess
whether investing in a particular fundmatches their expectations and needs interms of ESG investing.
2.3.25 Notwithstanding the preceding
paragraphs, should an Investment
Manager consider it necessary to pursue
IFSI in order to avoid a risk to an OPCVM’s
expected financial returns, it would,
in our view, also be entitled to do so,irrespective of whether the documentationof the OPCVM discloses that it may invest
for sustainability impact.
2.3.26 When managing French OPCVMs,
Investment Managers have legal freedom
to use investment powers to take ESG
considerations into account, provided
the documentation of the relevant
OPCVM is clear about its objectives
and the investment policy that is to be
implemented. Strictly speaking, theyshould equally be able to pursue IFSI,
although this probably remains hinderedby the traditional perspective that the

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPCONTENTS

A LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCEFOREWORDSINTRODUCTION

purpose of an investment fund is to yieldfinancial return for its Beneficiaries (unlessthe documentation of the OPCVM allows
the Investment Manager to pursue IFSI).
2.3.27 This issue also arises under French
corporate law, where article 1833 of theFrench Civil Code (Code civil) provides thatcompanies must have a lawful corporate
purpose and be constituted in thecommon interest of their shareholders.
This is conventionally understood as
requiring that a company’s objective is
to be profitable. This perspective wassignificantly altered by the PACTE law107
passed in spring 2019, which notably
introduced the following changes.
(a) Article 1833 Civil Code now states thatcompanies must be managed in their own‘corporate interests’ (as opposed to thoseof their shareholders) ‘by taking into
consideration the “social and environmental
issues” related to their operation’108.
(b) Article 1835 Civil Code has been amended
to allow companies to specify in theirarticles of association a ‘raison d’être’,
which the law defines as being ‘made upof the principles with which the company
is endowed and for the observance of
which it intends to allocate resources incarrying out its business’ 109.
(c) More importantly, French companies
are now allowed to adopt a new ‘status’,referred to as that of ‘mission-based
company’ (société à mission)110. Where acompany chooses this status, its articles
of association must not only state a raisond’être, but also define ‘one or several social
or environmental objectives that thecompany purports to pursue in carryingout its business’111.
2.3.28 The rules outlined in sub-paragraphs(a) and (b) above do not fundamentally
325

change the nature and objectives ofFrench companies but are meant to givethem the possibility to go beyond theobjective of being profitable. The creationof the mission-based company status goesa step further, as it allows companies
to be established to further social orenvironmental objectives. Creating asimilar status for funds (ie allowing funds
to be created with a purpose stated tobe other than yielding financial returnfor Beneficiaries 112) could be the stepnecessary to unlock their potential for
IFSI (and undoubtedly allow Investment
Managers to engage in ultimate ends IFSI
on behalf of French funds). This would
go beyond the current rules applicable toFrench funds, under which funds alreadyhave enough flexibility to IFSI (provided
their documentation is clear about it)113.
Funds could be established with the
purpose of pursuing ‘one or several social
or environmental objectives’ throughtheir investments.
2.3.29 The ability of Investment Managers to
use investment powers to IFSI on behalfof an OPCVM is also reflected by France’s
two public labelling regimes for funds,
which were both launched in 2016: the
SRI label114, driven by the Ministry of
Finance, and the Greenfin label115, driven
by the Ministry of Ecological and Inclusive
Transition. The SRI label116 requires thesystematic and measurable integration of
ESG criteria into investment decisions. It
is granted to funds117 that meet criteriagrouped into six topics: (a) the fund’s
general (financial and non-financial)
objectives (which must be clearly
defined and described to Beneficiaries
and taken into account in the fund’sinvestment policy); (b) the ESG criteria
analysis and rating methodology usedby the companies in which the fundinvests; (c) the inclusion of ESG criteria
during the portfolio’s development
and existence; (d) the ESG engagement
policy with the companies in which thefund invests (voting and dialogue); (e)fund management transparency; and (f)measurement of the positive impacts of
ESG management on the development of asustainable economy.
2.3.30 The Greenfin label is also based on
financial management transparency
and environmental impact indicators.
However, it is different in nature in thatthe investment scope is limited to funds
that genuinely finance activities withmeasurable environmental benefits. The
label aims at combining green share andexclusions: it is linked to a taxonomy ofsustainable activities in which labelledfunds must invest a specific percentage of
their portfolio. Labelled funds must also
exclude fossil and nuclear energies fromtheir investments.
118

2.3.31 A Banque de France study noted that
there were in 2019 379 SRI and Greenfin
labelled funds with €148bn in AuM,
representing almost 7 per cent of theFrench collective investment management
market119. In 2020, these numbers had
increased to 508 SRI labelled funds (with€204bn AuM)120 and 50 Greenfin labelledfunds (with €15bn AuM)121. The existenceof these two labels and the growing
number of funds they have labelledreflects a more established integration
by Investment Managers of ESG criteria
into investment decisions, and also an
increased use of their investment powers
to IFSI.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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2.4

Insurance undertakings

Companies) since most of the rules that are
relevant to IFSI are common to all types of
insurance undertakings and are set forth in
the Insurance Code.

Types of insurance undertaking covered
2.4.1

We consider in this analysis (i) life
insurance undertakings and (ii) general/
non-life insurance undertakings:

2.4.3• life insurance (assurance vie) undertakings

provide assurance, in consideration forthe payment of a premium, on death oranother defined event by payment of alump sum or fixed regular income. Life
insurance may also include annuities
on a contractual basis. In practice, life
insurance products are primarily used in
France as savings products; and• general/non-life insurance (assurance non-vie)

2.4.4

comprises types of policy which are notlife insurance, and which include, among
other things, sickness, fire and naturalforces, property and liability insurance. The
general insurer provides, in consideration
for the prior payment of a premium,assurance on the specific risk covered by
the insurance by paying out in case a valid
claim of the policyholder occurs.
2.4.2

326

French insurance undertakings may
be established in a number of different
forms, as listed in Annex III to Directive
2009/138/EC122 (Solvency II): company
limited by shares (société anonyme); mutual
insurance company (société d’assurance
mutuelle); provident institution registeredunder the SSC (institution de prévoyance régie
par le code de la sécurité sociale); provident
institution registered under the French
Rural Code (institution de prévoyance régie parle code rural); and friendly society registeredunder the French Mutuality Code(mutuelle régie par le code de la mutualité). We
formally consider in this annex only thoseundertakings governed by the Insurance
Code, viz. companies limited by shares andmutual insurance companies (Insurance

2.4.5

Solvency II applies to most French
insurance undertakings123. However,smaller undertakings, which mainly
consist of mutual undertakings (mutuelles),fall outside the scope of the directive.
This annex considers only Solvency II
Insurance Companies, which, given boththeir number and balance sheet size,
manage the chief part of French insurance
undertakings’ assets124.
The landscape for life insurance policies(which comprise life insurance contracts(contrats d’assurance vie) and capitalisation
contracts (contrats de capitalisation)) in France
can be divided into two products: ‘fonds
en euros’ contracts (ie with-profits policies
with a minimum guaranteed return) andunit-linked contracts (contrats en unitésde compte)125. In a fonds en euros contract,
investment decisions are left to theInsurance Company. However, the invested
capital, as well as any interest and year-end
bonus added to it, are guaranteed by the
Insurance Company. In contrast, in a unitlinked contract, even though the Insurance
Company remains owner of the underlying
assets (ie ‘units’), the investment risk
associated therewith is fully borne by thepolicyholder. In return, the policyholder
can determine the underlying assets
in which premiums are invested (suchunderlying assets typically are collective
investment schemes, including inparticular OPCVMs)126.
In each case, the key parties are:
• Asset Owner: Insurance Company.
• Beneficiaries: Beneficiaries of theinsurance undertaking are any natural or

legal persons who are entitled to benefit
under an insurance contract, including
policyholders. Besides, the shareholdersof an insurance company are typicallyconsidered to form a further category of
an insurer’s Beneficiaries because of theireconomic interest in the management of
an insurance company’s assets.
• Investment decision-maker: Insurance

Company or Investment Manager
appointed by Insurance Company.
Overview of investment duties and powers
2.4.6

2.4.7

The investment duties of Insurance
Companies are typically determined by theterms of the contract concluded with therelevant policyholder (for life insurance)and French law (including EU legislation
directly applicable in member states).

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

In France, the main investment duties
and powers of insurers are primarily set
out by:Australia• the statutory and regulatory provisions ofCanadathe Insurance Code; and• Regulation (EU) 2015/35 on the taking up

and pursuit of the business of Insurance
and Reinsurance127.
In addition, France complies withguidance of the European Insurance andOccupational Authority (EIOPA), suchas the opinion on sustainability within
Solvency II128 and EIOPA’s technical advice
on the integration of sustainability risks
and factors in the delegated acts under
Solvency II and IDD129.
2.4.8

ACKNOWLEDGEMENTS

Generally, the key investment duties of
insurers arising out of French law are
the following.

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GLOSSARY
REFERENCES(a) Prudent person principle. Solvency II
Insurance Companies must invest theirassets in accordance with the ‘prudent
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person’ principle (PPP) set forth in Article
L. 353-1 Insurance Code and detailed in
Articles R. 353-1 et seq. Insurance Code.
This means, in particular, that withrespect to the whole portfolio of assets,
Solvency II Insurance Companies are
required to invest in assets ‘whose risks
they can properly identify, measure,monitor, manage, control and report, andappropriately take into account in theassessment of their overall solvency needs’
130. Further, the PPP requires that all
assets of Solvency II Insurance Companies
are invested in such a manner ‘as toensure the security, quality, liquidity andprofitability of the portfolio as a whole’,
and that the relevant assets be locatedso as to ensure their availability131. Thisrequirement indicates that the main
objective of the PPP under the Insurance
Code is to ensure financial returnconsistent with the respective investment
objectives and having appropriate
regard to the risks involved. This is also
confirmed by the requirement that
assets held to cover technical provisions
be invested ‘in the best interest of allpolicyholders and beneficiaries taking into
account any disclosed policy objective’132.
The ‘best interest’ of Beneficiaries istypically met if the generated financial
return allows the Insurance Company
to meet in due course its financial
obligations to the Beneficiaries under the
relevant policies.
Should a conflict of interest arise, Solvency
II Insurance Companies are expressly
required to invest in the best interest ofpolicyholders and Beneficiaries133.
(b) Investment rules. Generally, Insurance
Companies are not required to invest in
particular categories of asset (although
327

they have to comply with diversification
duties and restrictions on assets which
are not admitted to trading on a regulated
financial market134). However, as regards
life insurance unit-linked contracts, theunderlying assets of such contracts must
be chosen among eligible assets, as listed
in article R. 131-1 Insurance Code.
(c) Duties under corporate law. As noted in
section 2.3.27, Article 1833 Civil Codewas amended in 2019 by the PACTE law
to state that companies must be managed
in their own ‘corporate interests’ (asopposed to those of their shareholders)and ‘by taking into consideration the“social and environmental issues”
related to their operation’135. The PACTE
law also amended French corporate
law to provide that directors of French
companies’ corporate and management
boards must take into account ‘social andenvironmental issues’ when determining
the orientation of the company’s businessand supervising how it is carried out136.
Therefore, French corporate law now
explicitly provides for a duty of directors
to consider ‘social and environmental
issues’ when operating the company.
This duty does not necessarily entail an
obligation to actively pursue IFSI though,since directors need to balance various
factors without any predeterminationof the outcome when deciding which
action to take. In particular, it would
require the proper consideration of both
long-term (sustainability) interests andthe interests of present shareholders. In
addition, French corporate law provides
that the remuneration policy of certain
listed companies must contribute, among
other things, to the company’s longterm interests and sustainability137. Theirremuneration policy must also set out

how the pay and employment conditionsof employees of the company were taken
into account when establishing the
remuneration policy138; where the policy isrevised, it must describe and explain how
it takes into account the votes and viewsof shareholders on the policy139. Theseobligations suggest that the considerationof a company’s long-term interests might
be justified in certain cases.
(d) Beneficiaries’ views. In 2018, the Fédérationfrançaise de l’assurance (FFA)140 formalisedin its Corporate Social Responsibility (CSR)
Charter141 its members’ undertaking toinclude, in the unit-linked policies they
manufacture, at least one underlying asset
with an ethical investment, charitableor climate label, including in particular
the EETC (Energy and Environment
Transition for Climate) label or the SRI(Socially Responsible Investment) label.
This voluntary undertaking was converted
into a statutory requirement by the PACTE
law142 passed in spring 2019. Under article
L. 131-1-2 Insurance Code, as amended
by the PACTE law, unit-linked contracts
manufactured by Insurance Companies
must, since 1 January 2020, include atleast one underlying asset that either
comprises a minimum percentage of
securities issued by companies oriented
towards social welfare (entreprises solidairesd’utilité sociale) or has been awarded astate-recognised label relating to either
ecological or energy transition financing
or socially responsible investment.
As from 1 January 2022, unit-linked
contracts will have to include at least one
underlying asset for each of the three
above categories and Insurance Companies
will be required to inform their clients ofthe percentage of underlying assets withineach contract meeting these conditions,

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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European Union
FranceJapan

Netherlands

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before they decide to invest. The aimof this provision of the PACTE law is tobetter inform clients of the possibility toinvest in ESG underlying assets and direct
investments into such underlying assets.
(e) Insurance distribution. Where an Insurance
Company also carries out insurance
distribution, it must act ‘honestly, fairly
and professionally with the best interestsof [its clients].’143 Further, it has to ensurethat any contract proposed is consistent
with the client’s insurance demands andneeds144. Where an Insurance Company
recommends life insurance contracts,
it must ensure that the recommended
contract(s) or option(s) are the mostsuitable for the relevant client and thatthey are, in particular, in accordance withthat client’s risk tolerance and ability tobear losses145.
(f) Reporting requirements. Life Insurance
Companies are subject to the same
reporting requirements regarding theirinvestment strategy as FRPS (as to which,see section 2.2.23(d)).
General insurance: legal requirements to use
investment powers to pursue IFSI
2.4.9

Under current French law, non-life
Insurance Companies are, in our view,not generally obliged to use investment
powers to invest for sustainability impact.

2.4.10 There is no explicit duty of insurers to
pursue IFSI. Article L. 353-1 Insurance
Code rather establishes the PPP as theoverarching investment rule applicable toInsurance Companies (see section 2.4.8(a)).
Consequently, the investment principles
provided under the Insurance Code do not
specifically address ESG or sustainability
risks, nor do they expressly require an
Insurance Company to take such risks
into account.
328

2.4.11 In respect of non-life insurance, when
considering its investment decisions,an Insurance Company must primarily
ensure that its investments areappropriate to enable it (i) to pay any
amount due to policyholders (or otherbeneficiaries) under the policies it has
underwritten; and (ii) remain compliant
with the solvency and other prudential
requirements applicable to it. Arguably,
as long as an Insurance Company is able
to pay the claims under the policies it has
underwritten, it will have invested in the‘best interest’ of policyholders (or otherbeneficiaries of the policies). Therefore, in
general, where a conflict arises between
sustainability impact and financial return,the investment would need to be madein favour of the Insurance Company’s
duty to be financially able to meet its
contractual undertakings (under its
policies) to the Beneficiaries.
2.4.12 Nonetheless, there may be circumstanceswhere ESG and sustainability risks may
materialise as financial risks that an
Insurance Company would have to take
into account when investing146. This would
be the case where the Insurance Company
determines that ESG risks may materiallyaffect either (i) the assets in which it
invests (eg in the shape of market risks)147;or (ii) the underwriting risk (eg in case ofproperty or natural forces insurance)148.
In both cases, it might be ‘prudent’ for
an Insurance Company to take such risks
into account, inasmuch as they would
be financially material. However, thequestion whether certain ESG risks canbe viewed as financially material depends
on the time period which underlies
the investment process and over which
potentially relevant risks are assessed.

2.4.13 As regards Beneficiaries’ views, neither the
PPP nor any other statutory or regulatory
obligations of non-life Insurance
Companies require them to assess theviews of Beneficiaries on whether theywish to pursue IFSI. Similarly, there is
generally no explicit obligation to alignthe investment with the sustainability
preferences of Beneficiaries.
2.4.14 Under French corporate law149, large
French companies150 must establish
mechanisms to prevent human rights
violations and environmental impacts
throughout their chain of production.
In this respect, in-scope companies
must draw up, implement and publish a‘vigilance plan’. The plan must include‘reasonable vigilance measures to identify
risks and prevent serious harm to humanrights and fundamental freedoms,
health and safety of persons andenvironment’151 and cover the activitiesof the relevant company, its direct orindirect subsidiaries, and subcontractors
and suppliers with which an establishedbusiness relationship is maintained.
2.4.15 The vigilance plan must include (a) amapping that identifies, analyses andranks risks; (b) procedures to regularly
assess, in accordance with the risk
mapping, the situation of subsidiaries,
subcontractors or suppliers with whom
the company maintains an establishedcommercial relationship; (c) appropriate
action to mitigate risks or prevent serious
violations; (d) an alert mechanism thatcollects reporting of existing or actual
risks, developed in working partnershipwith the trade union representativesof the company concerned, and (e) amonitoring scheme to follow up on themeasures implemented and an assessment

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

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FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCECONTENTSFOREWORDSINTRODUCTIONof their efficiency. In-scope companies are
expected to make their vigilance plans,
and regular reports on the implementationof the plan, public as part of their annual
reports152. Finally, failure on the part ofan in-scope company to comply with theabove obligations within three months
from receiving a formal notice, may resultin the competent jurisdiction issuing anorder for the company to comply or facefinancial penalties. In addition, a company
that would fail to comply with theseobligations could be held liable and obliged
to compensate for the harm that due
diligence would have helped to avoid153.
2.4.16 Although this corporate duty of vigilancedoes not expressly cover ‘investment’
activities, it is meant to apply to
all activities of in-scope companies.
Therefore, any French in-scope companies,
the business of which is to engage ininvestment activities, must cover suchactivities in their vigilance plan. In thisrespect, Insurance Companies should
include their investment activities intheir vigilance plan and take reasonablemeasures to ‘identify risks and prevent
serious harm to [the environment]’154.
This may in certain circumstances resultin a legal requirement to use investment
powers to pursue IFSI.
General insurance: legal freedom to use investment
powers to invest for sustainability impact
2.4.17 Under French law, non-life Insurance
Companies are, in our view, free to use
investment powers to pursue IFSI as longas it does not jeopardise their ability tocomply with prudential requirements andmeet their contractual undertakings.
2.4.18 This ability has arguably beenstrengthened following the changes to
French corporate law brought about by
329

the PACTE law (as to which, see section
2.3.27). As corporate entities, Insurance
Companies must be managed not only intheir own ‘corporate interests’ but also
‘by taking into consideration the “socialand environmental issues” related to theiroperation’155. Following the PACTE law,
their directors must take into account‘social and environmental issues’ when
determining the orientation of thecompany’s business and supervising how
it is carried out156.
Life insurance: legal requirements to use investment
powers to invest for sustainability impact
2.4.19 For the reasons set out in sections
2.4.10 et seq., we do not consider thatlife Insurance Companies are subject toa general obligation to use investment
powers to pursue IFSI (except where
the implementation of their corporate
vigilance plan would require them to doso (see section 2.4.16).
However, in contrast to non-life Insurance
Companies, life Insurance Companies
typically have longer time liabilities, which
they need to cover over a corresponding
longer investment horizon. This might
imply that long-term sustainability risks
are generally of greater relevance for life
Insurance Companies than for non-life ones.
In this respect, EIOPA therefore takes theview that for ‘(longer-term) life business, thelong horizon for cash-flows also means that
there may be room to consider the impact ofclimate change in the calculation of the best
estimate.’157 Further, EIOPA has pointed outthat where ‘undertakings have long-term
assets to match long-term liabilities theyshould consider whether climate change
would impact either their ability to holdthese assets over that time frame or their
expected cash-flows’158. Similarly, under the

Insurance Code, life Insurance Companies
are required in certain circumstances159 topublicly disclose how the main elementsof their investment policy regarding sharesare consistent with the profile and durationof their liabilities, in particular long-term
liabilities, and how they contribute to themedium-to-long-term performance of theirassets160. This reflects the expectation that life
Insurance Companies factor those constraints
into their relevant investment policy.
2.4.20 Insurance Companies that provide advice
on life insurance products are required
to assess the suitability of a product for
the relevant client, based notably on
information on the client’s investment
objectives and financial situation161.
Where the Insurance Company makes
recommendations on life insurance
products, it must ensure that therecommended product is suitable and‘in accordance with [the client’s] risk
tolerance and ability to bear losses’162.
Although the relevant provisions are
sufficiently broad to cover non-financial
objectives, such objectives are notexpressly mentioned. On the contrary,references to ‘investment objectives’,‘financial situation’, ‘risk tolerance’ and‘ability to bear losses’ suggest that themain criteria that must be taken into
account are financial ones.
2.4.21 However, unit-linked contracts must,since 1 January 2020, include at least one
underlying asset that either comprises aminimum percentage of securities issuedby companies oriented towards social
welfare (entreprises solidaires d’utilité sociale)or has been awarded a state-recognisedlabel relating to ecological or energy
transition financing or socially responsible
investment163. This new requirement is

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCECONTENTSFOREWORDSINTRODUCTION

aimed at better informing clients of thepossibility to invest in ESG underlying
assets by making sure that policies include
sustainable investments within the rangeof underlying assets that policyholders
can pick from. This indirectly requires life
Insurance Companies to take into accountBeneficiaries’ views on ESG investing(assuming such Beneficiaries elect to invest
in the relevant underlying assets). The
repercussion of this requirement should bethat, where an Insurance Company assesses
the suitability of a product for a client, it
should ask for information on that client’s
investment ESG views, so as to be able tosuggest investing in an ESG underlying
asset if that would meet the client’s
expressed needs and objectives.
Life insurance: legal freedom to use investment
powers to invest for sustainability impact
2.4.22 Under French law, life Insurance
Companies are, in our view, free to use
investment powers to pursue IFSI as longas (i) it does not jeopardise their ability tocomply with prudential requirements andmeet their contractual undertakings, and(ii) it is consistent with the objectives andneeds of the relevant policyholders.
2.4.23 Assessing the ‘best interest’ ofBeneficiaries under the PPP mighttypically be considered more complex
than in relation to non-life insurance
products. On the one hand, the ‘best
interest’ of life insurance policyholders
requires in particular securing contractual
pay-outs in respect of longer-term policies.
In addition, in respect of unit-linked
contracts, the policyholders’ expectationis generally that the relevant underlying
assets, the investment risk of which theybear, will increase in value over time. Also,
as has been set out by EIOPA, for ‘(longer330term) life business, the long horizon for
cash-flows also means that there may beroom to consider the impact of climatechange in the calculation of the best
estimate.’164 This might imply that life
Insurance Companies have some leeway
to integrate sustainability risks in theirinvestment decisions.
2.4.24 For unit-linked contracts, Insurance
Companies must now include at least
one ESG underlying asset among theunderlying assets that policyholders
may select (see section 2.4.21). Nothing
prevents Insurance Companies that
manufacture unit-linked contracts from
including more ESG underlying assets forpolicyholders to pick from and thereby
directing their investments to such assets.
These ESG underlying assets can include
funds that pursue IFSI.
2.4.25 Finally, disclosure obligations under the
French ESG reporting regime apply tolife Insurance Companies, which must
report each year information on how
they incorporate ESG criteria into theirinvestment policy, the type of ESG criteria
taken into account and how they exercise
voting rights attaching to investments
taking account of their ESG choices165.
This implies that life Insurance Companies
are, in principle, allowed to take ESG or
sustainability factors into account provided
that their investment decisions remain
consistent with the PPP as the overarchinginvestment principle (please refer tosection 2.4.8(a)) and do not jeopardise theirability to meet their (long-term) contractual
obligations to policyholders.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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3.

ASSET OWNERS’ USE OF THEIR POSITION TO ENGAGE IN STEWARDSHIP ACTIVITIES TO SECURESUSTAINABILITY IMPACT

3.1

The following section considers the extent
to which, and on what basis, each typeof Asset Owner is (a) legally required or(b) legally permitted or able to use its
position to influence enterprises in which
it invests by engaging in stewardship
activities designed to achieve positive
sustainability outcomes and minimise
negative sustainability outcomes.

have however resulted in an increase in
Asset Owners’ engagement with investee
companies and Investment Managers
investing on their behalf169.
3.1.3

Overarching considerations
3.1.1

3.1.2

331

French management companies havebeen required since 2011 to report to
Beneficiaries of their funds (including inparticular OPCVMs) how they exercise
voting rights in investee companies
to take account of the ESG choices
defined in their investment policy166.
This requirement was extended to most
French Asset Owners in 2016, as part ofthe creation of the French ESG reporting
regime (as to which, see section 2.3.15).
In the context of the transposition into
French law of Directive (EU) 2017/828167 as
regards the encouragement of long-term
shareholder engagement (Shareholders’
Rights Directive II or SRD II), the PACTE
law introduced new requirements
aimed at strengthening stewardship andaddressing short-termism and principalagent problems in the investment chain168.
As further discussed below, these newrequirements, which apply on a ‘comply
or explain’ basis, do not impose upon therelevant Asset Owners any explicit duty toengage with investee companies to achieve
positive or reduce negative sustainability
impact. In other words, Asset Owners
have no specific obligation to actively
pursue that aim. These requirements

3.2

Where the relevant investee company
is subject to the French corporate ‘dutyof vigilance’ (as to which, see sections
2.4.14 to 2.4.16), Asset Owners should also
consider whether such company complies
with its obligations thereunder. Indeed,
these obligations include a requirement
to implement a corporate vigilance plan(including, in particular, to avoid undueenvironmental harm), failing which theinvestee company may face financial
penalties and civil liability. Asset Owners
are therefore prompted to use theirposition to influence relevant investee
companies to avoid adverse financial
consequences for their investments.
Pension funds

Legal requirements to engage forsustainability impact
3.2.1

3.2.2

For the reasons set out in sections 2.2.24
through 2.2.28, AGIRC-ARRCO, the
FRR and FRPS do not have any express
duty under French law to engage forsustainability impact (although there
might be certain situations giving rise toa duty to take account of sustainability
impact, in particular where ESG or
sustainability factors are to be consideredfinancially material and IFSI is perceived as
mitigating their impact170).
FRPS are subject to the same generalengagement requirements as Investment
Managers (as outlined in sections 3.3.1 etseq.), where they invest, either directly or
through Investment Managers, in shares

listed on a regulated market171. In respectof such investments, FRPS must:(a) develop and publicly disclose an
engagement policy that describes how
they integrate shareholder engagement intheir investment strategy172;(b) publicly report, each year, on how they
implemented their engagement policy173;(c) publicly report, where Investment
Managers implement on their behalf their
engagement policy (including throughexercising voting rights), the place wheresuch Investment Managers disclose therequired voting information174;

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXES(d) require Investment Managers, with which
they enter into investment managementagreements or in whose funds they invest,
to provide them with information on how
their investment strategy and the way it
is implemented comply with the relevant
contractual arrangements entered intowith the FRPS and contribute to themedium-to-long-term performance of therelevant assets175; andJURISDICTION REPORTS(e) publicly disclose, when they invest throughInvestment Managers, how the agreement
they enter into with the relevant
Investment Manager incentivises it toengage with investee companies to improvetheir medium-to-long-term performance176.

Japan

3.2.3

As with the obligations applicable
to Investment Managers, the above
requirements generally apply on a ‘comply
or explain’ basis177. They do not include
any specific obligation for the relevant
FRPS to actively aim for an improvementof its investments’ sustainability impact.

Australia

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European Union
FranceNetherlands

South Africa
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United States

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Legal freedom to engage for sustainability impact
3.2.4

The rules applicable to AGIRC-ARRCO, the
FRR and FRPS do not prevent them fromengaging for sustainability impact.

3.2.5

Both the AGIRC-ARRCO Pension
Institutions and FRR have voluntarily
committed to implement an active
engagement approach. The AGIRCARRCO’s ESG Charter178 lists, amongst its
ESG principles, that AGIRC-ARRCO shall‘engage as shareholder and integrate
ESG issues into its engagement policies
and procedures’ and ‘demand, as muchas possible, that investee companies betransparent in respect of ESG issues’179.
The FRR has drawn up proxy voting
guidelines180 that apply to the Investment
Managers that manage its assets. These
guidelines, which call for the FRR’slong-term perspective as an investor181 to
be taken into account, specifically statethat any resolution submitted ‘on topics
of a social, ethical or environmental
nature’ must be assessed in light of the
UN Global Compact principles and the
FRR’s own socially responsible investment
guidelines182.

3.3• monitoring of investee companies on• conducting dialogues with investee

companies;• the exercise of voting rights and any otherrights attaching to shares held in investee
companies;• cooperation with other shareholders;• communication with relevant stakeholdersof the investee companies; and• managing actual and potential conflicts ofinterests in relation to their engagement.
In addition, Investment Managers must
publicly report, each year, on how they
implemented their engagement policy185.
The report must notably include a generaldescription of how they have exercised voting
rights and an explanation of their votes inrespect of the most significant decisions186.
3.3.2

Mutual funds

Legal requirements to engage forsustainability impact
3.3.1

332

Pursuant to article L. 533-22 FMFC,
Investment Managers (ie fundmanagement companies and asset
managers authorised under MiFID II183)
must develop and publicly disclose an
engagement policy that describes how
they integrate shareholder engagementin their investment strategy. Pursuant toarticle R. 533-16 FMFC, the engagement
policy must include the following items:(see section 2.3.17), Beneficiaries’‘exclusive benefit’ in the context of fundmanagement is traditionally associatedwith the aim of generating financial
return. The word ‘exclusive’ is quite
restrictive, inasmuch as it formally covers
only (exclusively) the interest of current
Beneficiaries in the relevant OPCVM. It
arguably excludes any interest that is notstrictly linked to being an investor in therelevant OPCVM, such as general social
or environmental interests (which benefit
not only the OPCVM’s Beneficiaries,
but also non-investors). Retaining thereference to the Beneficiaries’ ‘exclusive
interest’ may therefore be conducive toprioritising financial return over otherconsiderations, or at least voting forsustainability impact only where this goalis clearly aligned with an appropriate
financial performance (subject however
to the documentation of the OPCVM
expressly contemplating engaging forsustainability impact (see section 3.3.6)).

relevant matters, including social andenvironmental impact and corporate
governance184;

3.3.3

Investment Managers which do notcomply with their obligations todevelop, disclose and/or report on theimplementation of their engagement
policy must publicly disclose a clear
and reasoned explanation why they
have chosen not to comply with therelevant requirement (‘comply or explain’
approach)187. Any third-party may bringa claim to the competent French court tohave it require the Investment Manager
to comply with its obligations and impose
financial penalties pending compliance188.
However, article R. 533-16 FMFC expressly
states that Investment Managers must,when implementing their engagement
policy, exercise voting rights for the
exclusive benefit of the Beneficiaries ofthe funds that hold the relevant shares.
As with the concept of ‘best interest’

Legal freedom to engage for sustainability impact
3.3.4

3.3.5

From a strict theoretical perspective,
management companies of OPCVM may
consider that they have limited leeway toengage for sustainability impact, unless
this has a positive impact on financial
return. Management companies may
also be reluctant to charge the costs ofengagement activities for sustainability
impact to the OPCVM they manage.
However, neither French law nor AMF’s
guidance prevent management companies
from engaging for sustainability impact
with investee companies.
On the contrary, French managementcompanies have been subject toreporting requirements in respect of
their engagement policy since 2011.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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Even though these requirements, which
expressly cover ESG topics, are ‘procedural’
rather than ‘substantive’ in nature,
their existence shows in our view thatengaging for sustainability impact cannot
be regarded as inconsistent with thetraditional management companies’ duties
to OPCVMs and their Beneficiaries. France
Invest189 drew up in 2008 a charter covering
engagement principles for its membersthat are private equity Investment
Managers. The charter notably includes
principles for engaging with investee
companies for sustainability impact190.
3.3.6

333

As noted in section 2.3.22, the relationshipbetween an OPCVM and its managementcompany, on the one hand, and its
Beneficiaries, on the other hand, isprimarily contractual in nature. Clearly
disclosing in the OPCVM’s prospectus
that, in respect of the OPCVM’s
investments, the management company
may engage for sustainability impact
removes the tension between any suchengagement and the traditional duties ofmanagement companies to Beneficiaries.
Where an investor knowingly invests inan OPCVM that expressly contemplates
engagement for sustainability impact,
such investor’s best (or exclusive) interest
necessarily encompasses the same. In
the AMF ESG disclosure guidelines191,
the AMF acknowledges the possibility
for the documentation of an investment
fund to refer to an engagement policy,
and recommends providing Beneficiaries
with further information on how it iseffectively implemented192.

3.4

Insurance undertakings

General insurance: legal requirements to engage forsustainability impact
3.4.1

Non-life insurers are, in our view, notgenerally subject to a duty to engage forsustainability impact (although they may beunder a duty to have regard to sustainability
risks in certain circumstances, as outlined
in section 2.4.12).

• publicly report, each year, on how they
• publicly report, where Investment

Managers implement on their behalf their
engagement policy (including throughexercising voting rights), the place wheresuch Investment Managers disclose therequired voting information196;• require Investment Managers, with which

they enter into investment managementagreements or in whose funds they invest,
to provide them with information on how
their investment strategy and the way it is
implemented complies with the relevant
contractual arrangements entered intowith the life Insurance Company andcontribute to the medium-to-long-term
performance of the relevant assets197; andGeneral insurance: legal freedom to engage forsustainability impact
3.4.2

French law does not specifically regulate
stewardship activities of non-life Insurance
Companies but does not prohibit suchengagement either. Because non-life
Insurance Companies face, in relation
to some of the risks they insure against,
the adverse impact of climate change,
they can, in our view, legitimately engage
in stewardship activities with a view tominimising such impact on their potential
payment obligations. In this respect, we
would argue that such an engagement
is consistent with a non-life Insurance
Company’s duties to its Beneficiaries.

Life insurance: legal requirements to engage forsustainability impact
3.4.3

Life Insurance Companies are subject to thesame general engagement requirements
as Investment Managers (as outlined in
sections 3.3.1 et seq.), where they invest,
either directly or through Investment
Managers, in shares listed on a regulated
market193. In respect of such investments,
life Insurance Companies must:• develop and publicly disclose an

engagement policy that describes how
they integrate shareholder engagement intheir investment strategy194;

ACKNOWLEDGEMENTS

implemented their engagement policy195;• publicly disclose, when they invest throughInvestment Managers, how the agreement
they enter into with the relevant
Investment Manager incentivises it toengage with investee companies to improvetheir medium-to-long-term performance198•

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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3.4.4

As with the obligations applicable
to Investment Managers, the above
requirements generally apply on a ‘comply
or explain’ basis199. They do not include
any specific obligation for the relevant
life Insurance Company to actively aim
for an improvement of its investments’sustainability impact.

Life insurance: legal freedom to engage forsustainability impact
3.4.5

3.4.6

French law does not prohibit life
Insurance Companies from engaging forsustainability impact, including beyond
the requirements outlined in section
3.4.3. The FFA noted in its latest reporton the integration of ESG and climate
criteria in insurers’ investment strategies
that in 2018, 85 per cent of participating
insurers reported engaging with investee
companies on ESG or climate-related
topics, and 65 per cent and 80 per centreported engaging with Investment
Managers through, respectively, factoring
ESG or climate-related criteria whenselecting fund and managed accounts200.
However, a life Insurance Company’s
engagement for sustainability impact
cannot conflict with its duties topolicyholders. In this respect, a life
Insurance Company would, in particular,need to ensure that its engagement
does not jeopardise its ability to meetits contractual undertakings under
the policies it has underwritten, and isconsistent with the objectives and needs ofthe relevant policyholders.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

334

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4.

ASSET OWNERS’ ENGAGEMENT IN PUBLIC POLICY WORK TO SECURE SUSTAINABILITY IMPACT

4.1

The following section considers the extent
to which, and on what basis, each type ofAsset Owner is (a) legally required or (b)legally permitted or able to use its position
to engage in public policy work designed
to achieve positive sustainability outcomesand minimise negative sustainability
outcomes, for example, where these are
relevant to the value of portfolio assets.

4.2

Pension funds

4.2.1

Under French law, there is no explicit
obligation for any of the pension funds
covered in this annex to engage in public
policy work to secure sustainability
impact. However, since there might becertain situations giving rise to a duty totake account of sustainability impact (inparticular where ESG or sustainability
factors are to be considered financiallymaterial201), we believe pension fundoperators might have a duty to engage inpublic policy work to secure sustainability
impact if that can be perceived as
mitigating identified sustainability risks totheir portfolio.

4.2.2

4.2.3

335

Although they are not specifically allowed
to undertake public policy work, pension
funds are not explicitly prohibited fromdoing so by French law. Pension funds
therefore have in our view some leeway
to engage in public policy to securesustainability impact.
However, pension funds would need toascertain that any such engagement iscompatible with their legal and regulatory
duties and does not, in particular, conflictwith their duties to Beneficiaries. In
this respect, pension funds that do nothave direct duties to individuals that are
Beneficiaries of the plans (viz. AGIRC-

ARRCO and FRR) probably have more
flexibility to integrate engagement inpublic policy into their activities andjustify the associated costs (since they are
not subject to any requirement to avoid
Beneficiaries bearing undue costs). On
the other hand, PER Operators and FRPS
would face more difficulties, inasmuch
as such engagement does not generateany (measurable) positive financial effects
and they cannot, in our view, pass costs
associated with public policy engagement
to the Beneficiaries.
4.3

Mutual funds

4.3.1

Under French law, there is no explicit
obligation for OPCVMs to engage in public
policy work to secure sustainability impact.

4.3.2

The management company of an OPCVM
must manage it in the ‘best interest’ of the
OPCVM and its Beneficiaries, which also
applies to engagement in public policy
work. Engaging in public policy work may
be difficult to align with the ‘best interest’of an OPCVM and its Beneficiaries, since it
may not result in any quantifiable positiveeffect on the financial return of the
OPCVM. In addition, if such public policy
work is paid for by funds of the OPCVM,
the costs incurred may be considered‘undue’202 where the financed activities
do not have a measurable positive effecton financial return. In addition, themanagement company should not conduct
any activities that result in the interestsof any group of Beneficiaries being placed
above the interests of any other groupof Beneficiaries. This can be viewed as
requiring management companies toensure that its public policy work beequally beneficial to all Beneficiaries.

4.3.3

However, an Investment Manager could in
our view engage in public policy work if
the documentation of the OPCVM clearlystates that it will (and appropriately
inform Beneficiaries on associated costs),or even, in our view, where investing forsustainability impact is an objective of
the OPCVM.

4.4

Insurance undertakings

4.4.1

Under French law, there is no explicit
obligation for non-life and life Insurance
Companies to engage in public policy
work to secure sustainability impact.
However, since there might be certain
situations that give rise to a duty totake account of sustainability impact (inparticular where ESG or sustainability
factors are to be considered financiallymaterial203), we believe Insurance
Companies might have a duty to engage inpublic policy work to secure sustainability
impact if that can be perceived as
mitigating identified sustainability risks
to their portfolio. In any event, Frenchlaw does not prohibit such engagement
and Insurance Companies are free topursue such work, provided it remains
compatible with their legal and regulatory
duties and does not, in particular, conflictwith their duties to Beneficiaries.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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5.

ESTABLISHING NEW FUNDS TO INVEST FOR SUSTAINABILITY IMPACT AND AMENDING THE
TERMS OF EXISTING ONES

5.1

The following section considers the extent
to which it is possible for an Asset Owner
to set up a fund, policy or other productwith the express objective of IFSI.

5.2

Pension funds

5.2.1

Generally, French law does not prohibit
pension fund operators from establishingfunds with the express objective of IFSI.

5.2.2

In fact, to the extent the relevant pension
plans enjoy legal freedom to pursue IFSI,
they are also free to establish funds withthe express objective of IFSI. As noted
in sections 2.2.29 et seq., the contractual
framework governing the AGIRC-ARRCO
in our view gives Pension Institutions
flexibility for IFSI. Similarly, the framework
within which the FRR operates allows
for IFSI (see section 2.2.36). In the same
way as the FRR launched in June 2005
the first call for tenders to invest about€600m in an ESG-conscious manner204, it
could conceivably have launched a call for
tenders to invest for sustainability impact.
The limits facing the AGIRC-ARRCO andthe FRR in this respect are the same as
those outlined in sections 2.2.30 and 2.2.37
respectively (ie in broad terms that suchinvestments should still allow them tomeet their expected profitability, security,
liquidity and performance needs).

5.2.3

336

It would also be possible to amend therules applicable to pension funds to include
a more express investment objective of
IFSI. From a theoretical standpoint, thiswould be achievable unless the statutory
and regulatory provisions setting forth
the framework within which the relevant
pension funds must operate prevent such
an amendment.

5.2.4

5.2.5

In respect of the AGIRC-ARRCO, therelevant framework is set forth by the
AGIRC-ARRCO framework agreement205,
which is periodically agreed througha collective bargaining process
between employers’ and employees’
representatives. In addition, the AGIRCARRCO federation adopts from time
to time the AGIRC-ARRCO financial
guidelines206. The AGIRC-ARRCO
framework agreement states that theplan’s reserves must be managed ‘ina socially responsible manner’ andthat ‘environmental, social and good
governance impacts must be taken into
account in the framework of the plan’sinvestment policy’. In our view, nothing
would prevent the employers’ andemployees’ representatives from agreeing
to make express reference, for instance,
to a requirement to manage the plan’sreserves with the objective of IFSI (subject
always to the plan’s overall financial
sustainability). The AGIRC-ARRCO
financial guidelines could also be similarly
amended by the board of the AGIRCARRCO federation since, in our view, thiswould remain consistent with the current
AGIRC-ARRCO framework agreement.
As regards the FRR, the only reference tosustainable investment in the statutory
and regulatory regime applicable to itis that the executive board (directoire)of the FRR must regularly report to its
supervisory board (conseil de surveillance)
on how the FRR’s investment policy
guidelines have taken into account ESG
considerations. This gives considerable
leeway to the FRR to shape how its
investment guidelines should takeaccount of ESG considerations, including
IFSI. On that basis, the FRR has released
four successive versions of its Socially
Responsible Investment Strategy207. In thelatest version, the FRR states that it will‘continue to rely on its values as a longterm public investor to take into accountand measure the impact of its investments
while seeking to safeguard its enduring
objective of financial performance’208.
Under that policy, in order to ‘develop
its investments’ responsible dimension’,
the FRR notes that it will seek to ‘pursue
impact’ and will ‘define indicators andtools to measure its impact’209. Whenselecting the Investment Managers thatmanage its assets, it will ask them todemonstrate their ability to ‘work withand influence’ investee companies210.
In our view, nothing would prevent the
FRR from deciding to increase its focus
on IFSI in the next version of its Socially
Responsible Investment Strategy (subject,
as noted by the FRR, to continuing to meetits financial performance objectives).
Duties on those designing, manufacturing andproviding pensions
5.2.6

5.2.7

The AGIRC-ARRCO and the FRR are
not subject to product governancerequirements and have no specific duty inthis respect.
The PER plans regime requires that
Beneficiaries be offered the possibility
to select at least one alternative asset
allocation, including notably, for PERcol
and PERcat, an allocation allowing themto invest in social impact funds (fonds
solidaires) that invest in specific social
impact companies (entreprises solidaires

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

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REFERENCES

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d’utilité sociale), as defined under article
L. 3332-17-1 of the Labour Code211.
Social impact companies do not directly
include companies meeting solely ESG
or sustainability criteria212, but thisrequirement on PER Operators to designand offer plans that include social
impact funds fosters the establishmentof such funds. PER Operators that are
Insurance Companies are also subject toduties regarding unit-linked contracts(see section 5.4.2), which also fosters
investment in ESG or sustainable funds
through PERin plans that take the form of
an insurance product.
5.3

Mutual funds

5.3.1

French law does not prohibit or restrict
establishing OPCVMs that pursue IFSI.
As noted in section 2.3.13, AMF has
acknowledged since 2007 the possibility
to use non-financial criteria in the processof selecting financial instruments forinvestment by French funds213. Article 321120 GRAMF also provides that an OPCVM’s
prospectus may allow the sharing of the
OPCVM’s financial returns214, which showsthat an OPCVM may be established witha purpose stated to be other than solely
yielding (or maximising) financial returnfor Beneficiaries.

5.3.2

337

The French SRI and Greenfin labels215
are also an indication that an OPCVM
can be established to pursue IFSI.
In particular, article D. 128-2 of theFrench Environmental Code (Code del’environnement) states that the Greenfin
label must cover funds that ‘meet certain
criteria, particularly in relation to theirdirect or indirect contribution to thefinancing of the energy and ecologicaltransition […].’ Upon its creation in 2016,
French authorities noted that it wasmeant ‘to spotlight the investment funds
that finance the green economy, to spurthe creation of new funds, and to encouragecompanies to report the ‘green share’of their activities’216. As a matter of fact,
the growing number of Greenfin-labelledfunds217 reflects the creation of funds on
the French market that pursue IFSI.
5.3.3

5.3.4

Appropriate disclosure to Beneficiaries
is the overarching condition to be met
to establish an OPCVM purporting toinvest for sustainability impact, whether
in order to protect or enhance thefinancial performance of their investment(instrumental IFSI) or otherwise (ultimate
ends IFSI). As long as the OPCVM’s
documentation clearly and fairly reflects
a corresponding investment objective
and strategy, Beneficiaries can makean informed decision (reflecting theirpreferences, including ESG ones) toinvest in such a fund. By the same token,
the Investment Manager can have thefund IFSI while abiding by its duties to
Beneficiaries when implementing the
OPCVM’s documentation.
Similarly, existing OPCVMs may
amend their documentation to be able topursue IFSI, subject to the AMF’s
approval and giving advance notice toexisting Beneficiaries.

Duties on those designing, manufacturing andproviding mutual funds
5.3.5

Manufacturers of OPCVMs may become
subject to the Directive 2014/65/EU
on markets in financial instruments(MiFID II)218 product governancerequirements.219 Among other things, amanufacturer must ‘precisely identify thepotential target market for each financial
instrument and specify the type(s) of
client for whose needs, characteristics

and objectives the financial instrument
is compatible.’220 The manufacturer
must also identify any group(s) of clientsfor whose needs, characteristics andobjectives the financial instrument is notcompatible (the ‘negative target market’).
Pending the changes to the productgovernance regime contemplated in the
recent draft delegated directive publishedby the European Commission221, thecurrent obligation to define the ‘target
market’ does not expressly require
including the Beneficiaries’ sustainability
or other ESG-related preferences. However,French law neither prevents nor restricts
manufacturers (whether or not subject tothe MiFID II product governance regime)from integrating such preferences whenidentifying the target market.
5.3.6

Distributors of OPCVMs are subject tosimilar requirements, eg to ensure that
products and services that are intended to
be offered or recommended are compatible
with the needs and objectives of theidentified target market and an ongoingobligation to review this compatibility222.
Pending the entry into force of the Draft
MiFID II ESG Delegated Directive, theserequirements do not extend to Beneficiaries’
sustainability preferences. However, in mostcases, distributors of financial products,
such as OPCVMs, are required to inquire
about their clients’ or prospective investor’s
objectives and needs to offer them productsthat are suitable or at least adequate. In
the context of the increasing focus by
French investors – whether institutionalor retail ones – on ESG and sustainableproducts and the growing number of suchproducts available on the market, one could
argue that distributors’ general duty to
act honestly, fairly and professionally inaccordance with the best interests of their

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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clients should lead them to systematicallyinquire about Beneficiaries’ ESG or
sustainability preferences.
5.4

Life insurance products

5.4.1

French law does not prohibit life
Insurance Companies from designing andoffering new types of products that would
include IFSI as their investment objective.
Many Insurance Companies already offer
unit-linked contracts that include ESG,
social impact or sustainable finance funds.
Some of them have also created contracts
which exclusively include funds which
are labelled by the SRI label. Nothing
would therefore prevent Insurance
Companies from establishing unit-linked
contracts including exclusively funds
which would pursue IFSI, including in
our view ultimate ends IFSI (subject toidentifying the relevant target market
for such a contract, generally complying
with applicable product governancerequirements (as to which, see section
5.4.4) and ensuring that policyholders
receive appropriate information on thespecific features (including risks and costs)of such a contract).

5.4.2

338

In fact, under article L. 131-1-2 Insurance
Code, as amended by the PACTE law,
all unit-linked contracts manufactured
by Insurance Companies must, since
1 January 2020, include at least one
underlying asset that either comprisesa minimum percentage of securities
issued by companies oriented towards
social welfare (entreprises solidaires d’utilitésociale, ie social impact companies) or
has been awarded a state-recognisedlabel relating to ecological or energy
transition financing or socially responsible
investment (ie the SRI label or Greenfin
label223). As from 1 January 2022, unit-

linked contracts will have to include atleast one underlying asset for each of thethree above categories. Life Insurance
Companies will also be required to
inform their clients of the percentage ofunderlying assets within each contract
meeting these conditions, before theydecide to invest. The aim of thesechanges is to better inform clients of thepossibility of investing in funds holding
ESG- and sustainability-focused underlying
assets and direct investments into such
underlying assets.
5.4.3

Life Insurance Companies are therefore
generally allowed to create unit-linked
contracts with underlying funds that IFSI.
Similarly, they can amend contracts to
replace existing underlying funds by, and/or add, such funds. Where policies includea ‘fonds en euros’ part (ie a with-profit policy
with a minimum guaranteed return224), in
relation to which investment decisions areleft to the Insurance Company and not tothe policyholder, life Insurance Companies
can opt to integrate ESG criteria in theinvestment strategy of their fonds en euros.

Duties on those designing, manufacturing andproviding life insurance
5.4.4

French law has implemented the productoversight and governance regime
in relation to insurance products of
Directive (EU) 2016/97 on insurance
distribution (IDD).225Under article L. 516-1
Insurance Code, Insurance Companies
must specify, within their productapproval process, an identified target
market for each insurance product andensure that all relevant risks to such
identified target market are assessed.
The Commission Delegated Regulation(EU) 2017/2358 with regard to productoversight and governance requirements

for insurance undertakings and insurance
distributors 226 further determines thatthe identification of the target market
must be carried out at a sufficiently
granular level, taking into account thecharacteristics, risk profile, complexity
and nature of the insurance product,
and that manufacturers may, inparticular with regard to insurance-based
investment products, identify groups ofclients for whose needs, characteristics
and objectives the insurance product isgenerally not compatible227. Additionally,
manufacturers are required to only design
and market insurance products that arecompatible with the needs, characteristics
and objectives of the clients belonging to
the target market228. Insurance Companies
must also regularly review their insurance
products to assess at least whether the
product remains consistent with the needsof the identified target market229.
5.4.5

As is the case of the MiFID II productgovernance regime, the current IDD
product governance regime does not
explicitly address ESG or sustainability
preferences of Beneficiaries230. However,French law neither prevents nor restricts
manufacturers (whether or not subject
to the IDD product governance regime)from integrating such preferences
when identifying the target market. As
mentioned in section 5.4.2, the Insurance
Code requires life Insurance Companies
that manufacture unit-linked contracts
to include at least one underlying asset
labelled by the SRI label or Greenfin
label or which invests in social impact
companies (and from 1 January 2022, to
include at least one underlying asset ineach of these three categories).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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5.4.6

339

Life insurance distributors are subject
to similar requirements, eg to have inplace distribution arrangements that
ensure that the objectives, interestsand characteristics of policyholders are
duly taken into account and an ongoingobligation to review this231. In addition,
insurance distributors must act ‘honestly,
fairly and professionally with the bestinterests of [their clients].’232 They haveto ensure that any contract proposed isconsistent with the client’s insurance
demands and needs233. They must ensurethat the life insurance contract(s) or
option(s) they recommend are the mostsuitable for the relevant client and thatthey are, in particular, in accordancewith that client’s risk tolerance andability to bear losses234. In the context of
the increasing focus by French investors– whether institutional or retail ones
– on ESG and sustainable products andthe growing number of such products
available on the market, it would seemthat the distributors’ general duty to
act honestly, fairly and professionallyin accordance with the best interestsof their clients should lead them tosystematically inquire about Beneficiaries’
ESG or sustainability preferences.
This is supported by the PACTE law
requirement that all unit-linked contracts
manufactured by Insurance Companies
must, since 1 January 2020, include atleast one underlying asset that either
comprises a minimum percentage of
securities issued by companies oriented
towards social welfare (entreprises solidairesd’utilité sociale, ie social impact companies)or has been awarded a state-recognisedlabel relating to ecological or energy
transition financing or socially responsible
investment (ie the SRI label or Greenfin

label235). This statutory requirement
makes sense only if distributors inquire
about the social and sustainability
preferences of Beneficiaries.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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6.

INVESTMENT MANAGERS’ DUTIES TO IFSI

6.1

This section considers the extent to which,and in what circumstances, an Investment
Manager is required or permitted to invest
for sustainability impact on behalf of an
Asset Owner.

6.1.1

6.1.2

6.1.3

340

Typically, an Investment Manager’s
investment duties and powers areshaped by the terms of its contractual
arrangements with an Asset Owner as wellas its duties under French law.
Investment Managers generally act for
Asset Owners through managing assets
on a discretionary basis under investment
management agreements (mandats degestion) or dedicated funds (fonds dédiés).
From a regulatory perspective, this entails
the provision of portfolio management
services (gestion de portefeuille) or collective
management services (gestion collective)
respectively. Investment Managers may
also provide investment advice (conseil
en investissement) to Asset Owners, which
remain responsible for making theirown investment decisions based on theInvestment Manager’s advice.
Irrespective of the service they provide,
Investment Managers are subject to a
general duty to act honestly, fairly andprofessionally in accordance with the bestinterests of their clients236. They mustalso obtain the necessary information
regarding their client’s investment
objectives so as to enable the Investment
Manager to recommend to the client
services or investments that are suitablefor it (‘suitability test’)237. Where they
provide investment advice, Investment
Managers are also required to ‘understandthe financial instruments they offer orrecommend, assess the compatibility of
the financial instruments with the needsof the clients to whom [they provide]
investment services, also taking account of
the identified target market of end clients[...] and ensure that financial instruments
are offered or recommended only when
this is in the interest of the client.’238
6.2

ACKNOWLEDGEMENTS

6.2.2

Legal obligations with respect tosustainability impact

Powers of investment and divestment
6.2.1

Assessing the suitability of a service
or investment entails, among otherthings, taking into account the financial
situation and investment objectives of
the client. Under the standard suitability
test, there is currently no express
requirement to assess the client’s views
on sustainability. On the contrary, thestatutory requirement rather focuses ondetermining that the relevant service orinvestment is suitable and ‘in accordancewith [the client’s] risk tolerance andability to bear losses’. This lends credence
to the traditional view that the primaryobligation of Investment Managers
towards their clients is to generate
financial return. In addition, Investment
Managers’ duties are owed to their‘clients’, ie the Asset Owners. As a generalprinciple, Investment Managers haveno duties to act in the ‘best interest’239
of the underlying Beneficiaries and are
not meant to consider their objectives orpreferences. Finally, even though ESMA
considers it a ‘good practice’ for MiFID
firms to consider non-financial elements
and collect information on the client’s
preferences on ESG factors240, Investment
Managers currently have no regulatory
duty to proactively ask for the client’s
objectives with regard to the sustainabilityof the portfolio.

6.2.3

Similarly, there is no direct duty to
pursue IFSI that applies to Investment
Managers. In fact, Investment Managers
are required to implement their clients’
instructions, as incorporated in theircontractual arrangements (eg in theinvestment rules and limits set forth in an
investment management agreement). In
principle, these contractual arrangements
should reflect the rules that apply to therelevant Asset Owner and the Investment
Manager is therefore bound to apply thesame rules as the relevant Asset Owner
would if it managed its assets itself.
Where the contractual arrangements
between the Investment Manager andthe Asset Owner are silent on IFSI, theInvestment Manager has no duty to
pursue IFSI and may do so only to theextent that it is not inconsistent withthe client’s best interests and investment
objectives, as stated in the agreed
contractual arrangements. In this context,
the notion of ‘best interests’ should not
be understood to be limited to the Asset
Owner’s financial interests only. In acontractual relationship between an Asset
Owner and an Investment Manager, theAsset Owner might decide to incorporate
into the contractual arrangements
various views and preferences, including
in relation to sustainability, which theInvestment Manager is then contractuallybound to consider when considering its
client’s best interests.
The Asset Owners have primary
responsibility for ensuring that their
Investment Managers are contractuallyrequired to consider their ESG
requirements or preferences. The FRR
paved the way to do so in 2005 when it

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
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launched a call for tenders to invest about€600m in an ESG-conscious manner241.
More generally, Investment Managers thatare appointed to manage the FRR’s assets
must agree to comply with the FRR’s
investment policy guidelines.
6.2.4

In order to foster such approach, the
PACTE law242 introduced in 2019 newprovisions of the Insurance Code, which
apply to life Insurance Companies and
FRPS that invest in shares listed on aregulated market (eg Euronext). Where
they invest through an Investment
Manager, life Insurance Companies
and FRPS must include certain specificpieces of information in the investment
management agreement243. Under articles
L. 310-1-1-2 and R. 310-4 Insurance Code,the Insurance Company must make public,
in respect of each such agreement, among
other things, the following information:(a) how the agreement incentivises theInvestment Manager to align its
investment strategy and decisions withthe profile and duration of the Insurance
Company’s liabilities, including inparticular its long-term liabilities;(b) how the agreement incentivises theInvestment Manager to make investment
decisions based on an assessment of
the medium-to-long-term performance,
whether financial or non-financial, of theinvestee companies and to engage withsuch companies to improve their mediumto-long-term performance; and(c) how the method and time horizon of theassessment of the Investment Manager’s
performance and the Investment
Manager’s remuneration align with theprofile and duration of the Insurance
Company’s liabilities, including inparticular its long-term liabilities.
341

Where an investment managementagreement does not include any of theabove items, the Insurance Company must
publicly disclose why244.
6.2.5

In any event, an Investment Manager
should identify considerations relevant
to its investment decision-making
against the background (primarily) of
the investment management agreement(or other contractual arrangements) it
has entered into with the Asset Owner.
In order to fulfil its duty of care, an
Investment Manager’s decisions should
always take into account any matterswhich are financially material to thosedecisions. This may result in a duty toinvest for sustainability impact.

with the Asset Owner and contribute to
the medium-to-long-term performance ofthe relevant assets247; and(c) publicly disclose, when they invest throughInvestment Managers, how the agreement
they enter into with the relevant
Investment Manager incentivises it toengage with investee companies to improvetheir medium-to-long-term performance248.
6.4

Engagement to achieve sustainability impact
6.2.6

6.3

French Investment Managers are
subject to the same general engagement
requirements as those applicable tomanagement companies pursuant toarticle L. 533-22 FMFC245 (as outlined in
sections 3.3.1 et seq.) when they engage ininvestment management activities for theaccount of third parties.

Public policy work to achieve sustainability impact
6.4.1

In order to foster such engagement, FRPS
and life Insurance Companies must:(a) publicly report, where Investment
Managers implement on their behalf their
engagement policy (including throughexercising voting rights), the place wheresuch Investment Managers disclose therequired voting information246;(b) require Investment Managers, with which
they enter into investment managementagreements or in whose funds they invest,
to provide them with information on how
their investment strategy and the way it
is implemented comply with the relevant
contractual arrangements entered into

In any event, an Investment Manager has
a duty to take into account matters which
are financially material to its investmentrelated decisions. Where it identifies asustainability impact risk that is material
in this way, it must then decide, what (ifany) action to take in respect of it. The
Investment Manager may well conclude
that engaging with the one or moreinvestee companies is an appropriate way
to seek to minimise the relevant risk to its
Asset Owners’ portfolios.

6.5

There is no requirement under French
law for an Investment Manager toengage in public policy work to IFSI. An
Investment Manager would, therefore,
only be required to engage in public
policy work to pursue IFSI if the relevant
investment management agreement (orother contractual arrangements) required
it to do so.
Legal freedom to invest forsustainability impact

Powers of investment and divestment
6.5.1

The Investment Manager’s freedom topursue IFSI is limited by the investment
management agreement (or othercontractual arrangements) enteredinto between the relevant Asset Ownerand Investment Manager. Where theinvestment management agreement

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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remains silent on IFSI, some level offlexibility may however arise from theduties applicable to Asset Owners. Thismeans, where the Asset Owner has leeway
to invest for sustainability impact, theInvestment Manager should also find anenhanced degree of flexibility. However,
Investment Managers might be reluctant
to act on the basis of requirements thatthey are not necessarily familiar with,and the optimal scenario remains in ourview that the investment managementagreement should detail the Investment
Manager’s powers to pursue IFSI.
Engagement to achieve sustainability impact
6.5.2

Assuming that the investment
management agreement does notdetermine the circumstances ofengagement, Investment Managers will beable to engage for sustainability impact, aslong as this is aligned with the duty to act
in the client’s best interests. Investment
Managers may therefore be reluctant toengage to achieve sustainability impact ifthat was perceived to be likely to reduce
the financial return of the portfolio they
manage over the relevant investment
horizon, result in undue costs being
charged to the portfolio or result in any
adverse financial consequences for the
portfolios which the Investment
Manager manages.

Public policy work to achieve sustainability impact
6.5.3

In the absence of specific conditions
resulting from the investment
management agreement, an Investment
Manager benefits from a broad flexibility
to engage in public policy work. However,it should ensure that such work does
not raise conflicts with the relevant
Asset Owner’s interests. This requiresconsideration of the cost (if any) to theInvestment Manager’s clients and whether
the proposed public policy-related activity
is likely to result in any adverse financial
consequences for the portfolios which theInvestment Manager manages.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
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REFERENCES

342

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7.

LEGAL LIABILITY TO THIRD PARTIES FOR THE NEGATIVE SUSTAINABILITY IMPACT OF
ENTERPRISES IN WHICH PORTFOLIOS ARE INVESTED

7.1

This section considers the extent to which,regardless of the legal rules under which itis required to operate and its constitution,
an Asset Owner could be legally liable tothird parties for the negative sustainability
impact of enterprises in which it invests,
and whether an Investment Manager could
also be liable because of its role in assisting
the Asset Owner to invest in the relevant
enterprise and steward its investment.

7.2

Asset Owners

7.2.1

It is possible that Asset Owners could befound to have criminal or civil liability to
third parties for negative sustainability
impact of assets in which they are
invested. While this is generally likely
to be a remote risk, the risk of this typeof liability could increase as a resultof the developing political focus onsustainability issues, which has prompted
growing scrutiny from regulators, nongovernmental organisations (NGOs)
and the public. For example, the Paris
Administrative Court recently ruled that aliability action brought by environmental
advocacy groups alleging failure by
the French state to act in response to
climate change, was admissible249. Thisdecision follows several rulings by theConseil d’Etat250,which reveal increasing
focus on the French state’s obligations
regarding climate change and, moregenerally, environmental matter251. It is
not impossible that this type of claims
could start being brought against Asset
Owners, on various civil liability grounds,
as outlined below.

Criminal liability
7.2.2

7.2.3

7.2.4

343

It is unlikely that an Asset Owner would
be held criminally liable for the negative
sustainability impact of a company it has
funded. Exceptionally, criminal liability
might exist where a person has knowingly,
by aiding or abetting, facilitated the
preparation or commission of an offence.
The same applies to any person who, bymeans of a gift, promise, threat, order,or an abuse of authority or powers,
provokes the commission of an offence
or gives instructions to commit it252. Onthat basis, a French parent company may
be held liable as an accomplice in respectof offences committed by a subsidiary.
However, the arm’s length nature of
relationships between an Asset Owner andthe activities of its investee companies
makes such a liability highly unlikely. The
risks would be slightly higher if a relevant
investor had close day-to-day involvement
in and direction over the activities of theinvestee company. However, this is not
typical of the Asset Owners considered inthis annex.
Under the French ‘polluter pays’ principle,‘the costs of measures carried out toprevent, reduce and control pollution haveto be borne by the polluter’253. However,the principle does not entail criminal
liability. In any event, there would have to
be some direct intervention at operational
level in order for an Asset Owner to beviewed as a ‘polluter’ and have to bearsuch cost so, once again we consider suchliability unlikely.
Liability is also theoretically possible, forexample, if a nominee director appointed

by an Asset Owner assumed managerial
responsibility over relevant activities of
the investee company, and (a) generallycommitted or aided or abetted thecommission of the same offence as theinvestee company254; or (b) consented to,or instructed, a specific illegal act (suchas, for instance, pollution by dumping ofwastes255). However, only exceptionallywould an Asset Owner exercise therequired level of engagement in an
investee company’s operations to attract
this type of liability.
Civil liability
7.2.5

7.2.6

7.2.7

Under French tort law, the general ruleis that ‘any act of man, which causes
damage to another, shall oblige the person
by whose fault it occurred to repair
it’256. On that basis, three elements arenecessary to engage liability: (i) a fault(faute); (ii) a loss or injury (préjudice); and(iii) a causal link (lien de causalité) between
the two. The burden of proof of all theseelements falls on the claimant.
Articles 1240 and 1241 Civil Codeon liability in tort (responsabilité
extracontractuelle) are generally interpreted
as not including any limitation on thescope or nature of protected rights orinterests. There is no need to prove theexistence of a duty of care towards theclaimant. It is therefore possible that an
Asset Owner could be found to be liabletowards individuals harmed by an investee
company’s actions (or inaction) which
result in a negative sustainability impact.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

However, liability only arises from a fault
if there is a direct causal relationshipbetween the fault and the loss or injury.
Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCECONTENTSFOREWORDSINTRODUCTION

In addition, French law provides forcompensation for the loss or injury
suffered, as long as it is, notably, direct
and certain257. It may be difficult to showsuch causal link between an Asset Owner’s
behaviour and harm suffered by a third
party following an investee company’s
actions (or inaction) which result in anegative sustainability impact. Tort law
has traditionally played only a relatively
limited role in environmental protection.
This is principally because liability in tort
requires claimants to establish that they
have suffered personal harm as a resultof the defendant’s actions (or inaction).
Where the harm is to the environment
there is no claimant with standing to bringan action under traditional tort rules.
7.2.8

There are also special grounds underFrench law to pursue a claim in tortious
liability in the context of environmental
matters. First, France incorporated in 2005
into its Constitution the 2004 Charter for
the Environment (Charte de l’environnement).
The charter notably includes the following
provisions (emphasis added):(a) Article 1 – ‘Everyone has the right to live
in a balanced environment which shows
due respect for health.’258(b) Article 2 – ‘Everyone is under a duty toparticipate in preserving and enhancing
the environment.’259(c) Article 3 – ‘Everyone shall, in theconditions provided for by law, foresee andavoid the occurrence of any damage which
he or she may cause to the environmentor, failing that, limit the consequences ofsuch damage.’ 260(d) Article 4 – ‘Everyone shall be required, in theconditions provided for by law, to contributeto the making good of any damage he or she
may have caused to the environment.’ 261
344

7.2.9

In a 2011 priority preliminary ruling(Question Prioritaire de Constitutionnalité –QPC262), the French constitutional court(Conseil constitutionnel) held that, in lightof articles 1 and 2 of the Charter for theEnvironment ‘everyone is subject to a dutyof vigilance in respect of environmental
harm that could result from his or her
activities’263. More generally, articles 1 to
4 of the charter can be used as grounds topursue a claim in tortious liability.

7.2.10 Second, French law no. 2016-1087 on
the recapture of biodiversity, nature andlandscapes264 introduced new legislation inarticles 1246 to 1252 Civil Code regarding
environmental liability. Article 1246 Civil
Code affirms the principle of remediationof ecological prejudice: ‘Any person
responsible for ecological prejudice is liable
for the remediation thereof’265. Unlike
under the traditional principles of tortious
liability, the parties who are permitted tobring a claim for environmental loss neednot have suffered a direct and personal loss
or injury. Article 1248 Civil Code provides
that any individual or legal person withthe legal capacity and interest to do so canbring a claim, including (but not limited to)
the French state, the French Biodiversity
Agency (Office français de la biodiversité),
local municipal authorities or associations
whose role is to protect the environment
and that were established at least five years
before the commencement of the litigation.
7.2.11 Given the very broad scope of theserules, which are expressed to apply to‘any person’, they could theoretically be
used as grounds to bring claims against
Asset Owners. As noted in section 7.2.9,
the French constitutional court held that‘everyone is subject to a duty of vigilancein respect of environmental harm that

could result from his or her activities’266. The
ruling of the Paris administrative court
mentioned in section 7.2.1 was renderedagainst the French state on the basis ofarticle 1246 Civil Code267. One could argue
that Asset Owners’ investment activities
nowadays encompass taking certain steps
to limit or at least mitigate the negative
sustainability impact of their portfolio.
Given the Asset Owners’ greater focus
on ESG-related disclosure, prompted not
only by wider statutory or regulatory
requirements but also voluntary goodpractices, there is also an increased risk ofthird parties raising claims on the grounds
that Asset Owners have not fully achieved
the steps they have publicly stated theywould follow.
7.2.12 As mentioned in sections 2.4.14 etseq., large companies must draw up,
implement and publish a ‘vigilance
plan’, which must include ’reasonable
vigilance measures to identify risks andprevent serious harm to human rights andfundamental freedoms, health and safetyof persons and environment’268. and cover
the activities of the relevant company
and its direct or indirect subsidiaries.
Under this corporate duty of vigilance, acompany that would fail to comply withthese obligations could be held liable
and obliged to compensate for the harmthat due diligence would have helped to
avoid269. On that basis, a parent company
could be held liable for harm caused bya subsidiary if, for instance, it did notassess, in accordance with its plan’s risk
mapping, the situation of its subsidiaries
or did not take appropriate action to
mitigate risks or prevent serious violations
by its subsidiaries270.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCECONTENTSFOREWORDSINTRODUCTION

7.2.13 Otherwise, the likelihood of liability for aminority shareholder (as an Asset Owner
would generally be) is in our view fairly
remote as it would require circumstancesthat allow piercing the corporate veil
(ie where an Asset Owner would haveinterfered in the investee company’sbusiness or given it specific instructions).
We consider it unlikely that this would befeasible in relation to the usual activities
of an Asset Owner of the type described inthis annex.
7.3

Investment Managers

7.3.1

It is even less likely that Investment
Managers, as agents of their client
Asset Owners, would be found to haveliability to third parties for the negative
sustainability impact of investee
companies. However, as for Asset Owners
above, the risk of such litigation isincreasing, especially as regards potential
claims on the basis of the specific grounds
outlined in sections 7.2.8 et seq.

aided, abetted, facilitated or provoked the
preparation or commission of an offence271(eg through a nominee director appointed
on its behalf) but is highly unlikely.
Civil liability
7.3.4

The civil liability position is broadly
similar to that for Asset Owners. It would
be typical for the investment managementagreement to include indemnification
provisions such that the risk of any suchliability incurred in fulfilment of its duties
to the Asset Owner would in practice
be borne by the Asset Owner (absent
fraud or similar egregious conduct of theInvestment Manager).

ACKNOWLEDGEMENTS

Marc Perrone

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaCriminal liability

China

7.3.2

European Union

7.3.3

345

As for an Asset Owner, an Investment
Manager might have criminal liability
where it has direct involvement in
an investee company’s activities oroperations, and where those aredetermined to be criminal under the
relevant legislation. However, Investment
Managers would not generally have thenecessary degree of direct involvement for
criminal liability.
As an Investment Manager would not bea shareholder of the investee company,
it would not be possible for them tohave secondary liability (as described in
section 7.2.13). Liability as an accompliceis theoretically possible in very narrowcircumstances where the Investment
Manager can be demonstrated to haveFranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCECONTENTSFOREWORDSINTRODUCTION
1

2

Source: Impact assessment relating to the pension plans reform(Etude d’impact – Projet de loi organique relative au système
universel de retraite – Projet de loi instituant un système universel
de retraite; NOR : SSAX1936435L/Bleue-1; NOR : SSAX1936438L/
Bleue-1), 24 January 2020, p. 44.
The AGIRC-ARRCO acronym designates both the complementary
pension plan for private sector employees covered by the generalold-age pensions regime, and the national federation (Fédération
AGIRC-ARRCO) that oversees it.

3

Loi n° 2001-624 du 17 juillet 2001 portant diverses dispositions
d’ordre social, éducatif et culturel.

4

Article L. 135-6 of the French Social Security Code (Code de lasécurité sociale).

5

http://www.fondsdereserve.fr/documents/pr-SRI_awarded_
mandates_April_27_2006.pdf.

6

As at the end of 2018, the AGIRC-ARRCO had 18.8 million active
members and 12.88 million beneficiaries. It managed reserves(réserve de financement) amounting to €65.5bn (source: AGIRCARRCO, Chiffres clés 2019).

7

Accord national interprofessionnel du 17 Novembre 2017 instituant
le régime AGIRC-ARRCO de retraite complémentaire.

24

Article L. 135-11 SSC. These rules are found in Arrêté du 24 mai 2016
relatif au fonds de réserve pour les retraites (as amended).

49

The first ESG call for tenders was launched in 2005, with a total
investment amount of €600m. FRR’s last call for tenders was toaward 4 ‘Responsible active management: Japanese equities’
mandates. According to the FRR’s press release on this call for
tenders, ‘responsible active management means that applicantstake ESG aspects into account in their management processes,
in particular by incorporating the FRR’s exclusions policy (banned
weapons, tobacco and coal) and voting and engagement policy.
Applicants must produce quantitative and qualitative reports
illustrating the actions they have taken in this domain.’25

Article L. 224-1 FMFC.

26

Articles L. 224-3 and R. 224-1 FMFC and, for PER plans taking theform of insurance products, articles L. 131-1 and R. 131-1 Insurance
Code.

27

“Collective” PER (PERcol) and “mandatory” PER (PERcat (also referred
to as PERo)) are employer-sponsored plans. Employee participationin PERcol is voluntary whereas it is mandatory in PERcat (seesections 2.2.9 and 2.2.10).

50

FRR, 2013-2017 Responsible Investment Strategy, ’Introduction’, p. 2.

28

Article L. 224-3 FMFC.

51

Ibid.

29

Under article 2 of law no. 2014-856, social impact companies
include, among other types of companies, those companies that‘aim at contributing to sustainable development or energy transition’,but only if their activities also have a socially useful impact.

52

Ibid.

53

FRR, 2013-2017 Responsible Investment Strategy, ‘Overview of thefour strategic priorities and how the FRR intends to implement
them over time’, p. 4.

54

See http://www.fondsdereserve.fr/en/socially-responsible-investment/
exclusions-list, sections entitled ‘Prohibited weapons’ and ‘Tobacco
industry’.

55

See http://www.fondsdereserve.fr/en/socially-responsible-investment/
exclusions-list, section entitled ‘Coal’.

30

Article L. 385-4 Insurance Code.

31

See further details in section 2.4.8(a).

32Article L. 354-1 Insurance Code.

33

Article L. 385-5 Insurance Code.

34

Article R. 385-16-2 III Insurance Code.

35

Article L. 385-6 Insurance Code.

56

http://www.fondsdereserve.fr/documents/Dexia_AM_termination_
mandate_December_28_2009-2.pdf.

36

Articles L. 385-7-2 Insurance Code and L. 533-22-1 FMFC.

57

FRR, 2013-2017 Responsible Investment Strategy, ‘Introduction’, p. 2.

8AGIRC-ARRCO Financial Guidelines, 2019, article 6.

9

Loi n° 2019-486 du 22 mai 2019 relative à la croissance et latransformation des entreprises.

10

Articles L. 224-13 through L. 224-22 FMFC.

37

Article D. 533-16-1 FMFC.

58

Article L. 135-8 SSC. See footnote 42.

11

Articles L. 224-33 through L. 224-26 FMFC.

38

59

FRR, 2019-2023 Responsible Investment Strategy, p. 4.

12Articles L. 224-28 through L. 224-39 FMFC.

60

Article L. 224-3 FMFC.

13

Article L. 224-1 FMFC.

Though FRPS are free to choose which exact data to report, article
D. 533-16-1 FMFC suggests including the following information: (i)the consequences of climate change and extreme weather eventson the assets; (ii) changes in the availability and price of natural
resources; (iii) policy risks related to the implementation of national
and international climate targets; measures of past, (iv) current or
future emissions of GHG (both direct and indirect).

61

Under article 2 of law no. 2014-856, social impact companies
include, among other types of companies, those companies that‘aim at contributing to sustainable development or energy
transition’, but only if their activities also have a socially usefulimpact.

14

Article L. 224-8 FMFC.

15

Ordonnance n° 2017-484 du 6 avril 2017 relative à la créationd’organismes dédiés à l’exercice de l’activité de retraite
professionnelle supplémentaire et à l’adaptation des régimes deretraite supplémentaire en unités de rente.

16

Directive (EU) 2016/2341 of the European Parliament and of theCouncil of 14 December 2016 on the activities and supervision of
institutions for occupational retirement provision (IORPs).

39

Articles L. 385-7-1 II and L. 310-1-1-2 II Insurance Code.

40

Article R. 310-4 II Insurance Code.

41

Article 40 of the regulation of the AGIRC-ARRCO federation.

42

See footnote 22.

43

Since 2011 and until 2024, the FRR must each year pay €2.1bn to
the French social debt amortisation fund (Caisse d’Amortissement
de la Dette Sociale). As from 2025, the FRR must pay a yearlyamount of €1.45bn, until it exhausts its financial reserves (article
L. 135-8 SSC).

17

Source: Autorité de contrôle prudentiel et de résolution, List of
authorised insurance institutions as of 1 May 2020.

18

Article 40 of the regulation of the AGIRC-ARRCO federation.

19

AGIRC-ARRCO Financial Guidelines, Title II (Règlementation desplacements des fonds techniques).

44

Article L. 135-8 SSC.

20AGIRC-ARRCO Financial Guidelines, article 10.

45

21

AGIRC-ARRCO Financial Guidelines, article 11.

22

Article L. 135-8 SSC.

This obligation to manage the AGIRC-ARRCO’s reserves in ‘a socially
responsible manner’ is however not a statutory or regulatory
requirement but stems from the AGIRC-ARRCO’s rules, which are,strictly speaking, contractual.

23

French law sets out a defined timeframe for the pay-outs of the
FRR’s assets. Indeed, under article L. 135-6 SSC, the sums entrustedwith the FRR had to be managed until 1 January 2011. As from thatdate and up until 2024, the FRR must each year pay €2.1bn to the
French social debt amortisation fund (Caisse d’Amortissement dela Dette Sociale) to help finance the basic old age pension plan. As
from 2025, the FRR must pay a yearly amount of €1.45bn, until it
exhausts its financial reserves.

46

Preamble of the AGIRC-ARRCO Framework Agreement.

47

FRR’s investment policy guidelines must be consistent with ‘theprinciples of prudence and risk spreading, taking account of thedefined timeframe for utilisation of the Fund’s resources’ (article
L. 135-8 SSC).

48

FRR, 2013-2017 Responsible Investment Strategy, ‘Introduction’, p. 2.

346

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanada62

See section 2.2.23(d).

China

63

Ibid.

64

Directive 2009/65/EC of the European Parliament and the Councilof 13 July 2009 on the coordination of laws, regulations andadministrative provisions relating to undertakings for collective
investment in transferable securities, OJ L 302 17.11.2009, p. 32.

European Union

65

Directive 2011/61/EU of the European Parliament and of the Councilof 8 June 2011 on Alternative Investment Fund Managers andamending Directives 2003/41/EC and 2009/65/EC and Regulations(EC) No 1060/2009 and (EU) No 1095/2010, OJ L 174, 1.7.2011, p.
1–73.

66

There are currently 18 different regimes governing FIAs under French
law.

67

Articles L. 214-7 for SICAVs) and L. 214-8 (for FCPs) FMFC.

68

Article L. 214-8 FMFC.

69

Article L. 214-8-1 FMFC.

70

Article L. 214-7 FMFC.

71

There are very few self-managed SICAVs in France.

72

Articles L. 214-7-1 FMFC.

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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73

Article L. 214-9 FMFC.

74

Article 6 of the Commission Delegated Regulation (EU) 2016/438 of
17 December 2015 supplementing Directive 2009/65/EC with regard
to obligations of depositaries, OJ L 78, 24.3.2016, p. 11–30.

75

Article L. 214-9 FMFC.

76

The FMFC establishes basic rules for the authorisation, supervision,
structure and activities of OPCVMs and the information that they
are required to publish. These basic rules comprise, among otherthings, conduct, organisational and capital rules which managementcompanies must comply with. The FMFC contains statutory
provisions on the one hand and regulatory provisions on the otherhand. The FMFC’s statutory and regulatory provisions applicable to
OPCVMs are, respectively, articles L. 214-2 to L. 214-23-2 FMFC andarticles D. 214-1 to D. 214-31-2 FMFC.

347

77

The GRAMF contains regulatory provisions that implement thegeneral requirements set forth in the FMFC. As such, they provide
for more detailed and practical rules applicable to OPCVMs (articles
411-2 to 411-140 GRAMF) and their management companies(articles 321-1 to 321-152 GRAMF).

78

Articles L. 214-9 FMFC and 321-100 GRAMF. Managementcompanies are also subject to a ‘best interests’ rule in article
L. 533-22-2-1 FMFC: ‘management companies must act honestly,
fairly and professionally in accordance with the best interests ofinvestors’.

79

Article 321-101 GRAMF.

80

Article 321-101 GRAMF.

81

The GRAMF is supplemented by AMF implementing rules andguidance, which can take the form of instructions, positions or
recommendations. Instructions set forth AMF’s construction of the
GRAMF; as such they state how the rules are to be complied with.
Positions set forth AMF’s construction of statutory and regulatory
requirements that fall within the AMF’s supervisory authority; assuch they state how the AMF expects that such requirements becomplied with. Recommendations set forth best practices, which
the AMF suggests should be adopted by firms to achieve applicablelaws and regulations aim. Recommendations are not mandatory.

des actifs et application aux OPCVM se déclarant conformes à laloi islamique. Under that guidance, French management companies
are, for instance, able to select assets in a way that allows the OPCVM
to be Shariah compliant.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

101

The types of associations that are eligible recipients of such
donations are defined in the GRAMF.

102

Position AMF-DOC-2007-19 – Critères extra financiers de sélection
des actifs et application aux OPCVM se déclarant conformes à laloi islamique.

103

Position AMF-DOC-2012-15 – Critères applicables aux placements
collectifs de partage.

104

AMF, Third report on non-financial approaches in collective
investment schemes (Troisième rapport sur les approches extrafinancières dans la gestion collective), December 2020, § 2.3.1

105

Ibid.

106

Position-recommandation AMF-DOC-2020-03 – Informations àfournir par les placements collectifs intégrant des approches extrafinancières.

107

Loi 2019-486 du 22 mai 2019 relative à la croissance et latransformation des entreprises.

108

Article 169 PACTE law. This provision of the PACTE law also adjusted
articles L. 225-35 and L. 225-64 of the French Commercial Code
(Code de commerce) so that corporate and management boards
take into account ‘social and environmental issues’ as part of theirrespective duties.

109

Article 169 PACTE law.

110

Articles L. 210-10 to L. 210-12 Commercial Code, created by Article
176 PACTE law.

Australia

111

Article L. 210-10 Commercial Code. In addition, a mission-based
company must meet strict conditions to retain its status: quantified
objectives and monitoring procedures must be defined and an
independent third-party must be responsible for verifying theimplementation of the company’s objectives.

BrazilA. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

82

Position AMF – Critères extra financiers de sélection des actifs etapplication aux OPCVM se déclarant conformes à la loi islamique –DOC-2007-19.

83

Position-recommandation AMF-DOC-2011-05 – Guide desdocuments réglementaires des OPC, 17 July 2020, p. 11.

84

Position-recommandation AMF-DOC-2011-05 – Guide desdocuments réglementaires des OPC, 17 July 2020, p. 8.

85

Ibid.

86

Loi 2019-486 du 22 mai 2019 relative à la croissance et latransformation des entreprises.

87

This has been reflected in article L. 621-1 FMFC, which is theprovision of French statutory law that defines AMF’s responsibilities.

88

Position-recommandation AMF-DOC-2020-03 – Informations àfournir par les placements collectifs intégrant des approches extrafinancières.

89

Article L. 533-22-1 FMFC.

90

ie how the management company integrates ESG criteria in its
investment policy.

91

ie ESG-related information on the relevant fund’s investments.

114‘Label ISR’.

92

Article D. 533-16-1 FMFC.

115

93

Articles L. 214-9 FMFC and 321-100 GRAMF.

94

ESMA, Guidelines on key concepts of the AIFMD (ESMA/2013/600),
Guidelines on ‘collective investment undertaking’, § 12.

‘Label France finance verte’ or ‘Label Greenfin’, previously known
as the ‘label TEEC’ (Transition énergétique et écologique pour leclimat – Energy and Ecological Transition for the Climate Label).

116

United Kingdom

95

Ibid.

Décret n° 2016-10 du 8 janvier 2016 relatif au label investissementsocialement responsable.

96

Article 321-101 GRAMF.

117

United States

97

Article 321-101 GRAMF.

The ISR label was extended in July 2020 to also cover managed
accounts for institutional investors (ISR Label Guidelines, 23 July2020).

98

See section 2.3.15.

118

99

Please refer to section 2.2.40.

Articles D. 128-1 et seq. of the French Environmental Code (Code del’environnement).

100

Position AMF-DOC-2007-19 – Critères extra financiers de sélection

119

Source: E. Candus and J.-L. Le Goff, Banque de France Eco Note Pad,
§ 152, 13 February 2020.

112

Articles 1833 and 1835 Civil Code do not apply to OPCVMs,
including SICAVs.

113

For instance, social impact funds (fonds solidaires), which must
invest a minimum share of their assets in specific social impact
companies (entreprises solidaires d’utilité sociale), have played an
important role in the development of responsible investment inFrance. See also sections 2.3.21 et seq.

ANNEXESJURISDICTION REPORTS

CanadaChina

European Union
FranceJapan

Netherlands

South Africa

GLOSSARY
REFERENCES

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As at 31 August 2020. Source: Association française de la gestion
financière (AFG), https://www.afg.asso.fr/solutions-depargne/
presentation-isr/label-isr/.

121

As at October 2020. Source: French Ministry of Ecological andInclusive Transition, https://www.ecologie.gouv.fr/label-greenfin#e3.

122

Directive 2009/138/EC of the European Parliament and of theCouncil of 25 November 2009 on the taking-up and pursuit of thebusiness of Insurance and Reinsurance (Solvency II).

123

As at 1 May 2020, out of 683 authorised insurance undertakingsin France, 455 were Solvency II undertakings (source: ACPR online
register of insurance undertakings (liste des organismes d’assurance
actifs au 1er mai 2020)).

124

As at the end of 2018, the value of French Solvency II insurance
undertakings’ investment was €2,601bn at market value,
representing 35 per cent of the assets managed by insurers in theEurozone (source: Banque de France, Bulletin de la Banque deFrance, 227/4, Jan.-Feb. 2020).

125

126

127

Many policies combine both products, ie policyholders allocate a
portion of their premiums to the Insurance Company’s fonds en
euros and another portion to available units.
In 2018 and 2019, the proportion of life insurance premiums being
invested in unit-linked contracts was approximatively 28 per cent(source: Fédération française de l’assurance, 2019 Annual Report,
p. 10).
Commission Delegated Regulation (EU) 2015/35 of 10 October 2014
supplementing Directive 2009/138/EC of the European Parliamentand of the Council on the taking up and pursuit of the business of
Insurance and Reinsurance, OJ L 12, 17.1.2015, p. 1–797.

128

EIOPA-BoS-19/241, 30 September 2019.

129

EIOPA-BoS-19/172, 20 April 2019.

130

Article R. 353-1 I Insurance Code.

131

Ibid.

132

Ibid.

133

Article R. 353-1 I Insurance Code.

134

Articles R. 353-1 III and R. 332-16 Insurance Code.

135

Article 169 PACTE law.

136

See articles L. 225-35 and L. 225-64 Commercial Code, applicable toFrench companies limited by shares (sociétés anonymes).

137

See article L. 225-82-2 I Commercial Code, applicable to French
companies limited by shares (sociétés anonymes).

138

Article R. 225-56-1 3° Commercial Code, applicable to French
companies limited by shares (sociétés anonymes).

139

Article R. 225-56-1 6° Commercial Code, applicable to French
companies limited by shares (sociétés anonymes).

140

FFA is the trade association of French insurance companies (https://www.ffa-assurance.fr).

141

FFA, Charte de Responsabilité Sociale d’Entreprise.

142

Loi 2019-486 du 22 mai 2019 relative à la croissance et latransformation des entreprises, article 72.

143

Article L. 521-1 I Insurance Code.

144

Articles L. 521-4 I Insurance Code (non-life insurance) and L. 522-5 I

348

Insurance Code (life insurance).
145

Article L. 522-5 II Insurance Code.

146

EIOPA, Opinion on Sustainability within Solvency II, EIOPABoS-19/241, 30 September 2019, p. 5.

147

This is confirmed by EIOPA’s guideline, pursuant to which the‘undertaking should regularly review and monitor the security,
quality, liquidity and profitability of the portfolio as a wholeby considering at least: […] (d) the characteristics of the assets
including: […] (iv) sustainability’ (EIOPA, Guidelines on system ofgovernance, EIOPA-BoS-14/253, p. 13 et seq.).

148

EIOPA, opinion on sustainability within Solvency II, EIOPABoS-19/241, 30 September 2019, p. 5; EIOPA, EIOPA’s technicaladvice on the integration of sustainability risks and factors in thedelegated acts under Solvency II and IDD, EIOPA BoS-19/172, 30
April 2019, p. 23 et seq.

149

Articles L. 225-102-4 and L. 225-102-5 Commercial Code. These
provisions entered into force in 2017 following the enactment of Law
no. 2017-399 of 27 March 2017 on the corporate duty of vigilance forparent and instructing companies (Loi n° 2017-399 du 27 mars 2017
relative au devoir de vigilance des sociétés mères et des entreprises
donneuses d’ordre).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

150

This law covers large companies limited by shares (sociétésanonymes, sociétés par actions simplifiées and sociétés encommandite par actions) that meet the following criteria:(i) companies headquartered in France that employ at 5,000
employees in France, or at least 10,000 employees worldwide(including through direct and indirect subsidiaries); or foreigncompanies headquartered outside France, with French subsidiaries,
if those subsidiaries employ at least 5,000 employees in France.

151

Article L. 225-102-4 Commercial Code.

152

Article L. 225-102-4 Commercial Code.

153

Articles L. 225-102-4 II and L. 225-102-5 Commercial Code.

154

Article L. 225-102-4 Commercial Code.

155

Article 169 PACTE law.

156

See articles L. 225-35 and L. 225-64 Commercial Code, applicable toFrench companies limited by shares (sociétés anonymes).

157

EIOPA, Opinion on Sustainability within Solvency II, EIOPABoS-19/241, 30 September 2019, p. 5, 12.

158

EIOPA, Opinion on Sustainability within Solvency II, EIOPABoS-19/241, 30 September 2019, p. 5, 13.

159

Where they invest directly or through an Investment Manager inshares traded on a regulated market.

160

Article L. 310-1-1-2 II Insurance Code.

161

Article L. 521-4 I Insurance Code.

162

Article L. 522-5 Insurance Code.

163

Article L. 131-1-2 Insurance Code.

164

EIOPA, Opinion on Sustainability within Solvency II, EIOPABoS-19/241, 30 September 2019, p. 5, 12.

165

Articles L. 310-1-1-3 Insurance Code and L. 533-22-1 FMFC (seesection 2.3.15).

166

Article L. 533-22-1 FMFC.

167

Directive (EU) 2017/828 of the European Parliament and of theCouncil of 17 May 2017 amending Directive 2007/36/EC as regards
the encouragement of long-term shareholder engagement, OJ L
132, 20.5.2017, p. 1–25.

Japan

168

Article 198 PACTE law.

169

The French Insurance Federation (Fédération française del’assurance – FFA) noted in its second Report on the integrationof ESG and climate criteria in insurers’ investment strategies(Baromètre ESG-Climat – Intégration des critères ESG-climat dansles stratégies d’investissement des assureurs, 2e édition) that,in 2017 and out of the 5 criteria monitored in the study, French
insurers’ engagement with investee companies and Investment
Managers was the one that had progressed more.

South Africa

170

See section 2.2.27.

171

Articles L. 385-7-1 I Insurance Code and L. 533-22 I FMFC.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceNetherlands

United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCECONTENTSFOREWORDSINTRODUCTION
172

Article L. 533-22 I FMFC. See section 3.3.1 for details on the required
content of the policy.

173

Ibid.

174

Article L. 385-7-1 I Insurance Code.

175

Article L. 533-22 II FMFC.

176

Articles L. 385-7-1 II, L. 310-1-1-2 II and R. 310-4 Insurance Code.

177

p. 7.
201

See section 2.2.27.

202

Article 321-101 GRAMF.

203

See section 2.2.27.

204

http://www.fondsdereserve.fr/documents/pr-SRI_awarded_
mandates_April_27_2006.pdf.

See section 3.3.2. However, any third-party may bring a claim to thecompetent French court to have it require the FRPS to comply with
its obligations and impose financial penalties pending compliance(articles L. 533-22 III FMFC and L. 385-7-1 II and L. 310-1-1-2 III
Insurance Code).

205

Accord national interprofessionnel du 17 Novembre 2017 instituant
le régime AGIRC-ARRCO de retraite complémentaire.

206

Règlement financier.

207

For the periods 2005-2008, 2008-2012, 2013-2017 and 2019-2023.

178

Charte ISR de l’AGIRC-ARRCO, 26 June 2019.

208

179

AGIRC-ARRCO’s ESG Charter, Annex 1 ‘Principles for responsible
investing’.

FRR, 2019-2023 Responsible Investment Strategy, ‘Introduction –Bilan’, p. 2.

209

Ibid., ‘Incarner la gestion responsable’, p. 3.

180

FRR, Lignes directrices relatives à l’exercice des droits de vote.

210

Ibid., ‘Etendre la dimension responsable des investissements’, p. 5.

181

FRR Proxy Voting Guidelines, p. 3.

211

Article L. 224-3 FMFC.

182

FRR Proxy Voting Guidelines, section III, p. 17.

212

183

Article L. 533-22 FMFC primarily applies to fund managementcompanies (sociétés de gestion de portefeuille). Under article L. 53322-4 FMFC, Investment Managers authorised under MiFID II mustcomply with article L. 533-22 FMFC when they engage in investment
management activities for the account of third parties.

Under article 2 of law no. 2014-856, social impact companies
include, among other types of companies, those companies that‘aim at contributing to sustainable development or energy transition’,but only if their activities also have a socially useful impact.

213

Position AMF-DOC-2007-19 – Critères extra financiers de sélection
des actifs et application aux OPCVM se déclarant conformes à laloi islamique.

226

Commission Delegated Regulation (EU) 2017/2358 of 21 September
2017 supplementing Directive (EU) 2016/97 of the European
Parliament and of the Council with regard to product oversight andgovernance requirements for insurance undertakings and insurance
distributors, OJ L 341, 20.12.2017, p. 1–7.

227

Articles 5(1) and (2) Commission Delegated Regulation (EU)2017/2358.

228

Article 5 (3) Commission Delegated Regulation (EU) 2017/2358.

229

Article L. 516-1 Insurance Code and Article 7 Commission DelegatedRegulation (EU) 2017/2358.

230

EIOPA has taken the view ‘that insurance undertakings are notrequired to take ESG considerations into account when designingand manufacturing insurance products’ (EIOPA, EIOPA’s technicaladvice on the integration of sustainability risks and factors in thedelegated acts under Solvency II and IDD, EIOPA BoS-19/172, 30
April 2019, p. 14).

231

Article 10 Commission Delegated Regulation (EU) 2017/2358.

232

Article L. 521-1 I Insurance Code.

233

Ibid.

234

Article L. 522-5 II Insurance Code.

235

See sections 2.3.29 et seq.

236

Article L. 533-11 FMFC.

237

Article L. 533-13 I FMFC.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXES

184

Relevant matters also comprise strategy, financial and non-financial
performance, risk and capital structure.

214

See section 2.3.21.

238

Article L. 533-24-1 FMFC.

185

Article L. 533-22 I FMFC.

215

See sections 2.3.29 et seq.

239

186

Article R. 533-16 II FMFC.

216

Emphasis added.

187

Articles L. 533-22 I and R. 533-16 I & II FMFC.

217

See section 2.3.31.

Except where an Investment Manager acts as investment managerof an OPCVM, in which case it must act ‘in the interests of the
OPCVM and its investors’ (articles L. 214-9 FMFC and 321-100
GRAMF).

188

Article L. 533-22 III FMFC.

218

240

189

France Invest is the trade association of French private equity
investors (https://www.franceinvest.eu/en/).

ESMA, Guidelines on certain aspects of the MiFID II suitability
requirements, 6 November 2018, ESMA35-43-1163; para. 28.

241

190

France Invest, Charte d’engagements des investisseurs pour lacroissance, see section C.

Directive 2014/65/EU of the European Parliament and of the Councilof 15 May 2014 on markets in financial instruments and amending
Directive 2002/92/EC and Directive 2011/61/EU, OJ L 173, 12.6.2014,p. 349–496.

http://www.fondsdereserve.fr/documents/pr-SRI_awarded_
mandates_April_27_2006.pdf.

China

242

191

Position-recommandation AMF-DOC-2020-03 – Informations àfournir par les placements collectifs intégrant des approches extrafinancières.

Loi n° 2019-486 du 22 mai 2019 relative à la croissance et latransformation des entreprises.

European Union

243

192

AMF ESG disclosure guidelines, recommendation no. 6, p. 14.

Article 198 PACTE law. The same obligation applies where the life
Insurance Company invests through an investment fund. In such acase, the content requirements apply in respect of the subscription
agreement that is signed by the Insurance Company.

Japan

193

Articles L. 310-1-1-2 I Insurance Code and L. 533-22 I FMFC.

194

Article L. 533-22 I FMFC. See section 3.3.1 for details on the required
content of the policy.

219

Articles L. 533-24 and L. 533-24-1 FMFC. Management companies of
OPCVM are not required to observe the MiFID II product governanceobligations, unless they offer, recommend or market financial
instruments. However, an Investment Manager that collaborates
with a management company in establishing a fund may qualify
as co-manufacturer of the OPCVM (see ESMA, Guidelines on MiFID
II product governance requirements, Final Report, 2 June 2017,
ESMA35-43-620, § 60).

220

Article 313-11 GRAMF.

221

Commission Delegated Directive (EU) .../… of XXX amending
Delegated Directive (EU) 2017/593 as regards the integration ofsustainability factors and preferences into the product governanceobligations, Ref. Ares(2020)2955234 (Draft MiFID II ESG DelegatedDirective).

195

Ibid.

196

Article L. 310-1-1-2 I Insurance Code.

197

Article L. 533-22 II FMFC.

198

Articles L. 310-1-1-2 II and R. 310-4 Insurance Code.

222

Articles 313-19 and 313-21 RGAMF.

199

See section 3.3.2. However, any third-party may bring a claim to thecompetent French court to have it require the FRPS to comply with
its obligations and impose financial penalties pending compliance(articles L. 533-22 III FMFC and L. 310-1-1-2 III Insurance Code).

223

See sections 2.3.29 et seq.

224

See section 2.4.4.

225

Directive (EU) 2016/97 of the European Parliament and of theCouncil of 20 January 2016 on insurance distribution (recast), OJ L
26, 2.2.2016, p. 19–59.

200

349

FFA, Baromètre ESG-Climat – Intégration des critères ESG-climat
dans les stratégies d’investissement des assureurs, 3e édition), see

244

Article R. 310-4 Insurance Code.

245

Under article L. 533-22-4 FMFC, Investment Managers authorised
under MiFID II must comply with article L. 533-22 FMFC when they
engage in investment management activities for the account of
third parties.

246

Article L. 310-1-1-2 I Insurance Code (life Insurance Companies) and
Article L. 385-7-1 I Insurance Code (FRPS).

247

Article L. 533-22 II FMFC.

248

Articles L. 385-7-1 II, L. 310-1-1-2 II and R. 310-4 Insurance Code.

249

Tribunal administratif de Paris, 3 February 2021, Association
OXFAM France, Association Notre Affaire à Tous, Fondation pourla Nature et l’Homme, Association Greenpeace France, req.
N°1904967, 1904968, 1904972, 1904976/4.

JURISDICTION REPORTS

Australia

BrazilCanadaFranceNetherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGFRANCECONTENTSFOREWORDSINTRODUCTION250The Conseil d’Etat is the French highest administrative court.

251

On 10 July 2020, the Conseil d’Etat held that the government had
not taken the measures requested to reduce air pollution in eightareas in France and imposed a penalty payment of €10m for eachsemester of delay (CE, Ass., 10 July 2020, Les Amis de la Terre,
no. 428409). In the so-called ‘Grande Synthe’ ruling, the Conseil
d’Etat ruled for the first time on a case relating to compliancewith commitments to reduce greenhouse gas emissions (CE, 19
November 2020, Commune de Grande-Synthe et al., no. 427301).

252

Article 121-7 of the French Criminal Code (Code pénal).

253

Article L. 110-1 3° Environmental Code.

254

Article 121-2 Criminal Code.

255

See article L. 218-50 Environmental Code.

256

Article 1240 Civil Code: ‘Tout fait quelconque de l’homme, qui
cause à autrui un dommage, oblige celui par la faute duquel il est
arrivé, à le réparer.’ Article 1241 Civil Code further provides that ‘One
shall be liable not only by reason of one’s acts, but also by reasonof one’s imprudence or negligence.’ (‘Chacun est responsable dudommage qu’il a causé non seulement par son fait, mais encore
par sa négligence ou par son imprudence.’).

257

Civ. 3e, 28 June 2018, no. 17-18.755.

258‘Chacun a le droit de vivre dans un environnement équilibré etrespectueux de la santé.’

259‘Toute personne a le devoir de prendre part à la préservation et àl’amélioration de l’environnement.’

260‘Toute personne doit, dans les conditions définies par la loi, prévenir
les atteintes qu’elle est susceptible de porter à l’environnement ou,à défaut, en limiter les conséquences.’261‘Toute personne doit contribuer à la réparation des dommages
qu’elle cause à l’environnement, dans les conditions définies par la
loi.’

262

The QPC is a procedure by which a party to a lawsuit may challenge
a law for violating a right or freedom guaranteed by the French
constitution.

263

Cons. const. 8 April 2011, no 2011-116 QPC: ‘Chacun est tenu à une
obligation de vigilance à l’égard des atteintes à l’environnement
qui pourraient résulter de son activité.’264

Loi n° 2016-1087 du 8 août 2016 pour la reconquête de labiodiversité, de la nature et des paysages.

265

Under article 1247 Civil Code, ‘environmental loss’ means ‘a nonnegligible [ie significant] violation to the elements or functions of
ecosystems or to the collective benefits drawn by humans fromthe environment.’

266

Emphasis added.

267

Tribunal administratif de Paris, 3 February 2021, Association
OXFAM France, Association Notre Affaire à Tous, Fondation pourla Nature et l’Homme, Association Greenpeace France, req.
N°1904967, 1904968, 1904972, 1904976/4.

268

Article L. 225-102-4 Commercial Code.

269

Articles L. 225-102-4 II and L. 225-102-5 Commercial Code.

270

See article L. 225-102-4 Commercial Code.

271

See section 7.2.4.

350

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJAPANCONTENTSFOREWORDSINTRODUCTION

1.

INTRODUCTION

1.1

For the purposes of this annex, we haveconsidered the laws of Japan as at 31
January 2021. Sections 2 to 4 address
the ability of Asset Owners to Invest for
Sustainability Impact where the relevant
portfolio does not have an express
Sustainability Impact objective.1

1.2

As discussed in the main body of thereport, the expression ‘Investing for
Sustainability Impact’ is not a precisely
defined legal expression, and it isimportant to emphasise that the law ofJapan does not reference it in that way.
Rather, the expression is used here as a
type of ‘conceptual net’ to catch, in broad
terms, any activities of an investor of thesort described in the Introduction of themain report (paragraph 1.3.5).

1.3

Mandatary’s duty

1.3.1

An Asset Owner is entrusted with the assetsof the Beneficiaries and has the power tomanage assets on behalf of the relevant
Beneficiaries pursuant to the relevantlaws, the documents establishing therelevant fund (in the case of pension funds
and mutual funds), or insurance policies(in the case of insurance undertakings).
The Asset Owner would either invest theassets themselves or use the services ofan Investment Manager appointed by the
Asset Owner to manage the portfolio. The
Investment Manager has the power tomanage the portfolio on behalf of the Asset
Owner pursuant to the relevant investment
management agreement.

ACKNOWLEDGEMENTS

1.3.2

Under Japanese law there is a concept
of “mandatary’s duty” (jutakusha sekinin)similar to the concept of fiduciary duty
in common law countries. When a client
entrusts the management of funds toan investment manager, the investment
manager owes the mandatary’s duty
to the client. An Asset Owner owes
the mandatary’s duty to the relevant
Beneficiaries. An Investment Manager
owes the mandatary’s duty to the relevant
Asset Owner as well as the underlying
Beneficiaries in certain circumstances:
the Financial Instruments and Exchange
Act (the FIEA) provides an investment
manager’s duty of loyalty and duty of careowed to “right holders”2 (i.e., Beneficiaries)
and the Defined Benefit Corporate
Pension Law (the DB Law)3 and the DefinedContribution Pension Law (the DC Law)4
provide an investment manager’s duty ofloyalty owed to pension beneficiaries. The
provisions of these laws are interpreted as
codifying the general position of Japanese
law that an investment manager could
owe the mandatary’s duty to Beneficiaries.

1.3.3

The core of the mandatary’s duty consistsof the duty of care (zenkan chui gimu) andthe duty of loyalty (chujitsu gimu). The
most fundamental provision is Article
644 of the Civil Code, which provides
that a mandatary shall assume a duty toadminister the mandated business withthe care of a good manager in compliancewith the main purpose of the mandate.
Article 355 of the Companies Act, whichapplies to a Relevant Investor which is astock company formed pursuant to theCompanies Act (kabushiki kaisha, the mostcommon type of companies in Japan),provides that directors must performtheir duties for a stock company in a loyal
manner. With respect to the relationshipbetween the duty of care and the dutyof loyalty, the Supreme Court held on 24
June 19705 that the duty of loyalty is notseparate from the duty of care but rather it
represents one element of the duty of careas formulated by the courts. Since Article
644 of the Civil Code applies to all typesof Relevant Investors, even though someof them are not stock companies and,
therefore, Article 355 of the Companies
Act does not apply, it does not make apractical difference to the mandatary’s
duty owed by the Relevant Investors.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

351

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJAPANCONTENTSFOREWORDSINTRODUCTION

1.3.4

There is no published court case where
the court clarified what exactly the
mandatary’s duty means in the context ofinvestment management but, given thatthe main purpose of the mandate is togain financial return through investments,a Relevant Investor (i.e., an Asset Owneror an Investment Manager) owes to therelevant client (i.e., Beneficiaries or an
Asset Owner) the duty to seek to achieve a
positive investment return during the termof the mandate using the care and skill
expected for the same profession. We also
note that, given that investment inherently
involves risks and the investment
manager’s duty does not necessarily mean
it is required to “maximize” investment
return, the investment manager has acertain amount of discretion on how tomanage investments. The Tokyo District
Court6 held that an investment manager
is not held liable for breaching the dutyof care unless its investment decision
goes beyond the limit of discretion and,since the investment decision is highly
professional, it will not be regarded as
beyond the limit of discretion unless it isconsidered to be apparently unreasonablegiven the relevant factual situations,applicable laws and rules, and the terms of
the relevant investment agreement.

1.3.5

Applying the rule above to Investing for
Sustainability Impact, a Relevant Investor
is required to consider environmental andsocial factors in its investment decisions
where they are financially material to theperformance of the investment, balancing
returns against risks. On the other hand,
while a Relevant Investor is generally
prohibited from pursuing environmental
and social factors disregarding investment
returns, it may pursue environmental
and social factors if it reasonably believes
it will lead to achieve higher investment
return in the middle to long term by
maintaining or enhancing the corporate
value of investee companies, even if it
compromises investment return in the
short term. If the relevant documents
or insurance policy specifically include
an “Investment for Sustainability”
requirement, it would change the “mainpurpose of the mandate” and allow the
Asset Owner and Investment Manager to
put greater emphasis on environmental
and social factors even if it is expected toreduce investment returns (although there
could be a limit on how far investment
return can be reduced depending on
the terms of the relevant document or
insurance policy). Please refer to Section 5
for further discussion.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

352

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJAPANCONTENTSFOREWORDSINTRODUCTION

2.

ASSET OWNERS’ USE OF POWERS OF INVESTMENT AND DIVESTMENT TO INVEST FORSUSTAINABILITY IMPACT

2.1

The following section considers the extent
to which, and in what circumstances,each type of Asset Owner is (a) required or(b) permitted or able to use its powers ofinvestment and divestment to Invest for
Sustainability Impact.

2.2

2.2.4

Pension funds

Types of pension fund covered
2.2.1

2.2.2

2.2.3

353

The Japanese pension system is threetiered. The first two tiers are public
pensions consisting of the (a) National
Pension (referred to as the “basic pension”
and joined by Japanese nationals generally)and (b) Welfare Pension Insurance.
Employees of private companies, civil
servants, and teachers and employeesof private schools aged less than 70
are eligible to join the Welfare Pension
Insurance7 and it is paid in addition to
the National Pension. The funds for the
National Pension and a part of the Welfare
Pension Insurance are managed by theGovernment Pension Investment Fund(GPIF)8 and GPIF is the largest Asset Owner
in Japan. Benefits under the National
Pension and Welfare Pension Insurance are
guaranteed by statute.
The third tier consists of private pensions
paid in addition to the public pensions
above. Private pensions are categorised
into defined-benefit plans (DB Plans) anddefined-contribution plans (DC Plans).
A DB Plan is a pension plan for which
pension payments are pre-determinedbased on certain factors such as the time aparticipant enrolled in the plan. DB Plans
consist of contract-type plans and fund-type
plans. Contract-type plans are operated
by the employers and fund-type plans are

2.2.5

operated by corporate pension funds (DBPlan funds), which have a separate legal
personality from the employer.

Plan fund; for a corporate DC Plan, aparticipant and a DC Plan investment
adviser; for iDeCo, a participant.

A DC Plan is a pension plan where pension
payments are determined based on thefunds contributed and the return frominvestment of the contributions. DC Plans
consist of corporate plans and an individualplan called iDeCo. The corporate plans areoperated by employers which have received
approval by the Ministry Health, Labourand Welfare (the MHLW) of corporate planterms and iDeCo is operated by the National
Pension Fund Association (the NPFA).

GPIF, a mutual aid association, an
employer or a DB Plan fund sets
investment strategy but delegates dayto-day investment management to an
Investment Manager except for certainclasses of assets (e.g., government bonds
and passive bond funds).

The key entities are:
• Asset Owner: With respect to public

pensions, for the National Pension andspecial accounting reserve portion of the
Welfare Pension Insurance, GPIF; for the
management institution reserve portionof the Welfare Pension Insurance, therelevant mutual aid association; withrespect to private pensions, an employer
for a contract-type DB Plan, a DB Plan
fund for a fund-type DB Plan, and aparticipant for a DC Plan.
• Beneficiaries: Participants and ex-participants(a) Investment decision maker: With respect topublic pensions, for the National Pension
and the special accounting reserve portionof the Welfare Pension Insurance, GPIF, or
Investment Manager(s) appointed by GPIF;
for the management institution reserve
portion of the Welfare Pension Insurance,
the relevant mutual aid association, orInvestment Manager(s) appointed by themutual aid association; for a DB Plan, a
DB Plan fund or Investment Manager(s)appointed by an employer or a DB

Overview of investment duties and powers
GPIF (National Pension and Welfare Pension Insurance)
2.2.6

GPIF’s investment duties are set out by:(a) relevant laws and regulations, inparticular the Government Pension
Investment Fund Law, which provides,
among other things:(i)directors and employees of GPIF shallperform their duties carefully and withutmost attention and utmost effort9;(ii)

in performing their duties in relation
to asset management and investment,
directors of GPIF shall pay a “prudent
professional’s care” (defined as careequivalent to the care that a person
who manages and invests assets forothers pursuant to a mandate andmakes careful decisions based on
professional skill recognised generally
in relation to such business would takeunder similar circumstances)10; and(iii) pension reserve must be invested into
non-equity type securities, deposits,
trusts, life insurance products,
loans, bond options, forward foreignexchange trading, currency options,and derivatives, and be managed
safely and efficiently11;

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJAPANCONTENTSFOREWORDSINTRODUCTION(b) the Basic Guideline to Have theManagement and Investment of Reserve
be Made Safely and Effectively fromthe Long-Term Perspective issued by
the Ministry of Internal Affairs andCommunications, Ministry of Finance,
Ministry of Education, Culture, Sports,
Science and Technology and MHLW (theBasic Guideline), which provides, among
other things:(i)

investment of pension reserves must
be made for the benefit of participants
and safely and effectively from a longterm perspective to ensure the Welfare
Pension Insurance’s stability into the
future12; and(ii) based on the understanding thatsustainable growth of investee
companies and the market isnecessary to increase long-term
gain by investing pension reserves,a management institution shallconsider investment based on
ESG (environmental, social, andgovernance matters)13;(c) the mid-term goals issued by the MHLW(the Mid-Term Goals), which provide,
among other things:
(i)

(ii)

GPIF shall not manage pension reservesto achieve policies or goals disregarding
the benefit to participants14;
GPIF shall aim to achieve a grossinvestment return of 1.7% per annum
at the minimum risk in the long run15;(iii) to gain long term benefit for theinterest of participants, GPIF shall
increase its stewardship activities
bearing in mind the effect to themarket16; and(iv) based on the understanding thatsustainable growth of investee354

companies and the market isnecessary to increase long-term gain
by investing pension reserves, GPIF
shall enlarge ESG investment andreview if the ESG investment is in linewith the basic policy of investment of
GPIF from time to time17;(d) the mid-term plan, annual plan,management and investment plan, andbusiness plan prepared by GPIF, whichreflect the Mid-Term Goals; and(e) the mandatary’s duty under the Civil Code18.
Mutual aid associations (Welfare Pension Insurance)
2.2.7

2.2.8

There are many Welfare Pension
Insurance schemes for different groupsof employees. As an illustration, we
describe below the Federation of National
Public Service Personnel Mutual Aid
Associations (FNPSPMAA), which manages
Welfare Pension Insurance for national
government employees.
FNPSPMAA’s investment duties are set
out by:(a) relevant laws and regulations, inparticular the Welfare Pension Insurance
Law and Federation of National Service
Personnel Mutual Aid Law, which provide,
among other things:(i)

FNPSPMAA shall particularly notethat pension reserves are a partof the pension premiums paid by
the Welfare Pension Insurance
participants and an importantsource for future pension payments:
FNPSPMAA shall manage pension
reserves from a long-term perspective
and safely and effectively for thesole benefit of the participants sothat the Welfare Pension Insurance
business can be safely operated into
the future19;(ii) FNPSPMAA shall manage andinvest retirement benefit reservesin accordance with the Retirement
Benefit Reserve Management andInvestment Policy20; and(iii) pension reserves shall be invested
into certain trades in securities,
deposits, trusts, life insurance
products, loans, bond options,forward foreign exchange trading,currency options, and derivatives21;(b) the Basic Guideline, which provides,
among other things:(i)

investment of pension reserves must
be made for the benefit of participants
and safely and effectively from a longterm perspective to ensure the Welfare
Pension Insurance’s stability into the
future22; and(ii) based on the understanding thatsustainable growth of investee
companies and the market isnecessary to increase long-term
gain by investing pension reserve,a management institution shallconsider investment based on ESG23;(c) the Welfare Pension Insurance Benefit
Reserve Management and Investment
Policy, which provides, among other things:(i)

FNPSPMAA shall particularly notethat pension reserves are a partof the pension premiums paid by
the Welfare Pension Insurance
participants and a vital source for
future pension payments: FNPSPMAA
shall manage pension reserves froma long-term perspective and safely
and effectively for the benefit of
the participants so that the Welfare
Pension Insurance business can besafely operated into the future24;

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJAPANCONTENTSFOREWORDSINTRODUCTION(ii) FNPSPMAA shall aim to achievea target investment return at theminimum risk in the long run25;(iii) for the sake of the safe and effective
management of pension reserves,
FNPSPMAA shall invest the pension
reserves mainly to bonds by itself
as well as delegate investment to an
investment manager26;(b) a plan policy, basic investment plan, andinvestment plan, which vary by DB Plan,
but provide, for example;(iv) in investing pension reserves toachieve financial return, FNPSPMAA
shall take into account and analyse
ESG, which are non-financial
elements, in addition to financial
elements and make ESG investments
as necessary27; and(ii) asset diversification requirements;(v)

FNPSPMAA shall secure function
to dutifully fulfil its mandatary’s
duty (to comply with the duty ofloyalty and the duty of care as agood manager) and obtain humanresources necessary to perform its
business appropriately28; and(d) the mandatary’s duty under the Civil Code29.
Employer / DB Plan fund (DB Plan)
2.2.9

Investment duties of an employer / DB
Plan fund are set out by:(a) relevant laws and regulations, inparticular the DB Law, which provides,
among other things:
(i)

355

(ii) the employer and the DB Plan fundmust invest pension reserves safely
and effectively31;

the employer, the directors of the DB
Plan fund, the administrators of the
DB Plan fund, and any Investment
Manager who contracts with the DB
Plan fund must perform their duties ingood faith on behalf of (in the case of
the employer and the administratorsof the DB Plan fund) the beneficiaries
and (in the case of the directors of
the DB Plan fund and the Investment
Manager) the DB Plan fund30; and(i)investment policy to achieve safe andeffective management of pension
reserves; and(c) the Guideline on Investment Management
Entities’ Role and Responsibility in
Relation to Defined Benefit Corporate
Pensions issued by the MHLW, which
provides, among other things, that an
employer / DB Plan fund must perform its
duties loyally to participants with the careof a good manager and in compliance withthe relevant law and the MHLW’s orders
and rules32; and(d) the mandatary’s duty under the Civil Code33.
Legal requirements to use investment powers to
Invest for Sustainability Impact
GPIF (National Pension and Welfare Pension Insurance)
2.2.10 Currently there are no legal requirements
directly or indirectly requiring GPIF
to use investment powers to Invest for
Sustainability Impact except where the
GPIF has decided that climate changeor any other sustainability factor is amaterial risk to financial return of its
portfolio (please see 2.2.15 (c) below).
2.2.11 Mutual aid association (Welfare Pension
Insurance) and employer / DB Plan fund
(DB Plan)
2.2.12 Currently there are no legal requirements
directly or indirectly requiring mutual
aid associations or employer / DB Plan
funds to use investment powers to Invest
for Sustainability Impact except where

the mutual aid association or employer /DB Plan fund has decided that climatechange or any other sustainability factor
is a material risk to financial return of its
portfolio (please see 2.2.16 (d) below)..
2.2.13 Legal freedom to use investment powers to
Invest for Sustainability Impact
2.2.14 GPIF (National Pension and Welfare
Pension Insurance)
2.2.15 The duties of GPIF are flexible enough toallow GPIF to use investment powers to
Invest for Sustainability Impact in certain
circumstances (discussed below).
(a) Good for financial return. GPIF, as an Asset
Owner, needs to manage pension reserves
so that guaranteed pension benefits can be
paid in future. GPIF’s main mandatary’s
duty owed to beneficiaries with respect toinvestment is to secure the best realistic
return over the long term given the needto control for risks. Further, the MidTerm Goals prohibit GPIF from managing
pension reserves to achieve policies or goals
disregarding the benefit to participants34(which is understood to mean financial
return). In relation to ESG investments,
the Mid-Term Goals state, “based on theunderstanding that sustainable growthof investee companies and the market
is necessary to increase long-term gain
by investing pension reserves, GPIF shallenlarge ESG investment and review if the
ESG investment is in line with the basic
policy of investment of GPIF from time
to time.”35 In its mid-term plan, GPIF
states that based on the understandingthat sustainable growth of investee
companies and the market is necessary
to increase long term financial returnof portfolio, GPIF shall consider ESG
factors in addition to financial factors
in investment and review its effect to

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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achieve long term financial return for the
beneficiaries interest36. Given that, GPIF
can Invest for Sustainability Impact only
if it leads to financial return (which is
not necessarily short-term), and GPIF canInvest for Sustainability Impact where
GPIF reasonably believes it will lead toachieving a higher investment return inthe middle to long term by maintaining or
enhancing the corporate value of investee
companies that are held in the portfolio,
even if it compromises investment returnin the short term. Hence, instrumental IFSI
(pursuing sustainability objectives for the
purpose of achieving a financial return)is permissible as long as GPIF reasonably
believes that a it will lead to a higher
investment return in the mid- to long-term.
(b) “Tiebreak” scenario. The discussion in (a)above does not necessarily mean that
there is no scope to pursue Sustainability
Impact separate from investment
return to the extent that doing so does
not jeopardise investment return andSustainability Impact can be considered ina “tiebreak” scenario (where investment
return would be the same whichever
option is pursued), although suchsituations may be rare.
(c) Material financial risk. once the GPIF has
decided that climate change or any othersustainability factor is a material risk tofinancial return of its portfolio, it willthen have a duty to decide what, if any,action to take and to act accordingly. GPIF
could conclude that instrumental IFSI isthe appropriate response if it reasonably
determines that it can provide an effective
way of addressing the risk

356

Mutual aid association (Welfare Pension Insurance)and employer / DB Plan fund (DB Plan)

especially given that the mutual aid
association, or employer and DB Plan
is not legally required to confirm thebeneficiaries’ view. Taking these together
it would be difficult in practice for themutual aid association, or employer andDB Plan fund to rely on the beneficiaries’
view to Invest for Sustainability Impact.

2.2.16 As with GPIF, the duties of mutual aid
associations and employer and DB Plan
funds are flexible enough to allow themto use investment powers for Investment
for Sustainability Impact in certain
circumstances (discussed below).

(d) Material financial risk. Once mutual
aid association, employer or DB Plan
fund has decided that climate changeor any other sustainability factor is amaterial risk to financial return of its
portfolio, it will then have a duty to
decide what, if any, action to take and toact accordingly. Mutual aid association,
employee and DB Plan fund could
conclude that instrumental IFSI is theappropriate response if it reasonably
determines that it can provide an effective
way of addressing the risk, i.e leading toachieve a higher investment return inthe middle to long term. Also, mutual aid
association, employer and DB Plan fund
may also conclude that it should pursue
ultimate ends IFSI to reflect beneficiaries
view, while, as stated above, it is only atheoretical possibility.

(a) Good for financial return. The discussion in
2.2.11(a) equally applies to mutual aid
associations and employer and DB Plan
funds. This is the flexibility to consider
financially material ESG factors relevantto the risk-adjusted financial return of theportfolio over the relevant timeframe.
(b) “Tiebreak” scenario. The discussion in 2.2.11(b)equally applies to mutual aid associations
and employer and DB Plan funds.
(c) Beneficiaries view. Given that mutual aid
associations and employer and DB Plan
funds owe the mandatary’s duty tobeneficiaries, the beneficiaries view canshape their mandatary’s duty. Therefore,
theoretically, if the beneficiaries wish themutual aid association, or employer or
DB Plan fund to Invest for Sustainability
Impact, it is possible to argue that themutual aid association, or employer or
DB Plan fund can Invest for Sustainability
Impact without the need to consider
its financial return. However, there aremany practical issues when applying thisto reality. Since there is no mechanism
to aggregate the beneficiaries’ opinion,
the view of the beneficiaries’ needs willprobably need to be shared unanimously,
which will be quite rare. Further, toavoid being accused of breaching the
mandatary’s duty, the mutual aid
association, or employer or DB Plan fundwould want the beneficiaries view to beclear and specific, which is very difficult

2.3

Mutual funds

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Types of mutual fund covered

Netherlands

2.3.1

South Africa

Among various types of collective
investment schemes sold in Japan, themost common forms are investment
trusts. An investment trust is a special
type of trust set up pursuant to the
Law concerning Investment Trusts andInvestment Corporations (the LITIC) andboth, publicly offered and privatelyoffered, investment trusts exist. The
Financial Services Agency (the FSA) is theregulator. A typical investment trust works
as follows. An investment management

United Kingdom
United States

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company sets up a trust as a settlor (anInvestment Trust Manager, an ITM) witha trust bank as a trustee and solicits
investors to buy units. Investors buy units
in the trust and the trustee invests thetrust assets in securities and other financial
assets in accordance with the instructionsof the ITM. The investors share profits andloss from the investment pro rata to thenumber of units they hold. There is a tradeassociation called The Investment Trust
Association, Japan but it has not adopted
any guideline or policy relating to Investingfor Sustainability Impact.
2.3.2

There are two types of investment funds:(a) an investment fund where an ITM asa settlor has the investment power37 (aSettlor Managed Fund); andOverview of investment duties and powers
2.3.4(a) relevant laws and regulations, inparticular the LITIC and the FIEA;
the LITIC provides, among other things:
(i)

2.3.3

The key entities are:
• Asset Owner: A trustee but, since an ITM

is responsible for day-to-day managementof investment and making investment
decisions, we analyse below theinvestment duties and powers of an ITM
unless otherwise specified.
• Beneficiaries: Current unitholders• Investment decision-maker: An ITM ordelegated Investment Manager.

357

prohibition on acquiring morethan 50% of the voting rights of any
one company39;(ii) disclosure of potential conflicts ofinterests to unitholders40; and(iii) periodic disclosure of the results ofinvestments to unitholders41.
the FIEA provides, among other things:(i)duty of loyalty and duty of care owed
to unitholders42; and(ii) prohibition on various activities
including self-trading, trades
between the assets it manages, loss
compensation, unjustifiable trade
aimed at benefits for itself or a third
party, and trade on abnormal terms
detrimental to beneficiaries43;(b) an investment fund where a trustee has theinvestment power38 (a Trustee Managed Fund)but since the vast majority of publiclyoffered investment trusts are Settlor
Managed Funds (as of 31 January 2021, all
5,913 publicly-offered investment trusts
were Settlor Managed Funds), we focus ona Settlor Managed Fund below.

An ITM’s investment duties and powers
are set out by:(b) the investment fund’s investment trust
agreement, which provides among otherthings, the category of assets in which toinvest and the investment policy, which isdetermined by the ITM and filed with the
FSA; and(c) the mandatary’s duty under the Civil Code44.
Legal requirements to use investment powers to
Invest for Sustainability Impact
2.3.5

Although there are situations (discussed
below) where an ITM is potentiallyrequired to use investment powers to
Invest for Sustainability Impact, weare of the view that the current law
does not generally require an ITM touse investment powers to Invest for

Sustainability Impact (but please see 2.3.5(c) below).
(a) Material financial harm. An ITM needs tomanage an investment trust in accordancewith the investment policy set out in theinvestment trust agreement and disclosed
to unitholders. Its main mandatary’s dutywith respect to investment owed to theunitholders is to achieve the best possible
investment return under the investment
policy. As set out in 1.3.5, the ITM isrequired to consider environmental andsocial factors in its investment decisions
where they are financially material to theperformance of the investment, balancing
returns against risks. However, thesituations in which this comes into playwill be limited.
(b) Systemic risk. When there is social orenvironmental systemic risk which does
not have a material financial effect over
the relevant investment time horizonof the trust but one could materialisein future and cause a material adverse
effect on the investment trust assets, theITM could be required to look at suchrisk depending on the end date of theinvestment trust. However, what the ITM
can do alone will be not enough to address
such systemic risk and cooperation
with other investors will realisticallybe required. Since there is no legal
requirement for the ITM to cooperate withother investors, in our view, the ITM is
not required to Invest for Sustainability
Impact to prevent systemic risk which
is not yet financially material to theinvestment trust assets.
(c) Material financial risk. However, if an ITM
has decided that climate change or any
other sustainability factor is a material
risk to financial return of its portfolio, it

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJAPANCONTENTSFOREWORDSINTRODUCTION

will then have a duty to decide what, if
any, action to take and to act accordingly.
An ITM could conclude that instrumental
IFSI is the appropriate response if it
reasonably determines that it can provide
an effective way of addressing the risk,
i.e leading to achieve a higher investment
return in the middle to long term.

out in its investment trust terms (toushi
shintaku yakkan) to allow for ultimate
ends IFSI. A change of investment
objectives or policy in the investment
trust terms to permit ultimate ends IFSI,
even if an existing financial objective
retains its primacy, will amount to a“material” change to the investment trust
terms requiring approval by unitholders
with a three quarters majority.

Legal freedom to use investment powers to Invest for
Sustainability Impact
2.3.6

The duties of an ITM are flexible enoughto allow the ITM to use investment powers
to Invest for Sustainability Impact incertain circumstances (discussed below).

(a) Good for financial return. As set out in
2.3.5(a) above, an ITM’s main mandatary’s
duty with respect to investment owed
to the unitholders is to achieve the best
possible investment return under theinvestment policy. The discussion set
out in 2.2.12(a) will equally apply toan ITM: unless inconsistent with theinvestment policy. The ITM can Invest
for Sustainability Impact where theITM reasonably believes it will lead toachieving a higher investment returnin the middle to long term (but during
the life of the investment trust) by
maintaining or enhancing the corporate
value of investee companies that are heldin the portfolio, even if it compromises
investment return in the short term. Thisis the flexibility to consider financiallymaterial ESG factors relevant to the riskadjusted financial return of the portfolio
over the relevant timeframe. Please referto section 9 for further discussion.

358

2.3.7

Other than in the cases mentioned
above, the following requirements cause
issues for the IMT wishing to Invest for
Sustainability Impact.

(d) Undue cost. While there is no explicit
requirement on cost, an ITM may
not incur undue costs from the view
point of its mandatary’s duty. When
it is not disclosed to unitholders thatinvestment trust assets will be Invested
for Sustainability Impact, associated costs
may be regarded as undue costs.
2.4
2.4.1

(a) Disclosed investment policy. The investment
policy of the investment trust is disclosed
to unitholders through the investment
trust agreement and prospectus.
Investment activity must be conductedin compliance with the disclosed
investment policy. Currently an ITM is
not required to disclose whether or not
an investment trust’s investment policy
includes Investment for Sustainability
Impact. The ITM could hesitate to Invest
for Sustainability Impact where the statedinvestment policy of the trust does notinclude Investing for Sustainability Impact
due to potential liability to unitholders
if investment activity is not conducted inaccordance with the disclosed policy.

(b) “Tiebreak” scenario. The discussion in
2.2.12(b) equally applies to an ITM.

(b) Valuation. The investment trust assets
need to be valued periodically basedon a valuation method set out inthe investment trust agreement anddisclosed to unitholders. Investment
for Sustainability Impact is inherently
difficult to evaluate and poses challenges
for valuation.

(c) On amending investment trust terms. An
existing investment trust may amend
its investment objectives or policy as set(c) Expertise. The ITM may not be confident
that it has sufficient expertise to engage in
Investment for Sustainability Impact.

Insurance undertakings

Types of insurance undertaking covered

2.4.2

A life insurance company is licensed towrite life insurance where the insurancecompany undertakes to make a lumpsum or fixed regular payment on survival
or death of a person in exchange forreceiving insurance premiums. Contractbased pension policies provided byinsurance companies are included
within the definition of life insurance.
The amount of insurance payments iseither fixed or variable and fixed-type life
insurance products are common in Japan.
Variable-type life insurance products
include an investment-result-linked
insurance (e.g., certain types of variableannuities, an IRLI) where the amount of
insurance payments changes dependingon the results of investment to a
“specified account” (mainly an investment
trust) which a policyholder chooses fromthe selection of funds provided by the
insurance company.
A general insurance company (songai
hoken kaisha in Japanese, which is literallytranslated to a “damage insurancecompany”) is licensed to write non-life
insurance where the insurance company
undertakes to cover damage caused byan accident such as fire insurance, carinsurance, and liability insurance. The
general insurance company makes
insurance payments in an amount

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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which covers the damage (subject to a
pre-agreed cap) when a valid claim ismade. Investment risk does not lie with
policyholders so long as the insurancecompany is solvent.
2.4.3

We have excluded from the analysis
below: (a) mutual and (b) small shortperiod insurers, although the analysis may
be still relevant to these types of insurers.

2.4.4

The key entities are:
• Asset Owner: Insurer.
• Beneficiaries: Policyholders. As notedat ([X] front-end), for the purpose of thisreport we are treating shareholders of
an insurer as “Beneficiaries” since theirinterests are affected by investments madeby the insurer.
• Investment decision maker: Insurer or an

Investment Manager appointed by
the insurer.
Overview of investment duties and powers
2.4.5

An insurance undertaking’s investment
duties and powers are set out by:(a) relevant laws and regulations, in particular
the Insurance Business Act (the IBA);The IBA provides:
(i)

(ii)

that investment of assets suchas money received as insurance
premiums as the core business of an
insurance company be integrated with
underwriting insurance undertaking45;
limits on types of assets in which toinvest and exposure to a single entity46;(iii) policy reserve requirements47; and(iv) solvency margin48;(b) for “Specified Insurance” (which isdefined as insurance with a risk of loss
due to the movement of interest rates,
foreign exchange rates, market price or359

other indices) such as IRLIs, disclosure
requirements under the IBA49 and FIEA50
including, among other things, therequirement to explain investment policy
and the results of the investment;(c) FSA’s Comprehensive Supervision
Guideline for Insurance Companies
and Inspection Manual for Insurance
Companies, which require appropriatemonitoring and management ofinvestment risk;(d) the duty of care and the duty of loyalty
a director of a stock company (mostinsurance companies are stock companies)
owed to the company under theCompanies Act51, which generally meansthat a director should act to increase
shareholders’ interest; and(e) for IRLIs, the mandatary’s duty under the
Civil Code52.
General insurance: Legal requirements to use
investment powers to Invest for Sustainability Impact
2.4.6

actions for the interest of the company
in light of systemic sustainability risks,
which may or may not include Investingfor Sustainability Impact.
(b) Once the directors of a general insurer
have decided that climate change or any
other sustainability factor is a material
risk to financial return of its portfolio,
the directors will then have a duty to
decide what, if any, action to take andact accordingly. Options can include
instrumental IFSI where it could provide
an effective way of addressing the risk. A
general insurer may also pursue ultimate
ends IFSI within the limits discussed in
2.4.8 and 2.4.9 below.
General insurance: Legal freedom to use investment
powers to Invest for Sustainability Impact
2.4.7

There is flexibility for a general insurer
to use investment powers to Invest for
Sustainability Impact to some extent.

2.4.8

Vis-à-vis policyholders, a general insurer
is only required to pay valid claims
and the results of investment by thegeneral insurer do not directly link to
payment to policyholders. Given that,
we consider that the general insurer isfree to exercise investment power solong as it keeps sufficient funds to pay
valid claims, although there are someregulatory restrictions on investment(such as regulatory capital requirement
and portfolio diversification requirement),
which would limit Investing for
Sustainability Impact in some way. Unlike
a life insurer selling Specified Insurance,
a general insurer is not restricted by aparticular investment policy.

Although there are situations (discussed
below) where a general insurer ispotentially required to use investment
powers to Invest for Sustainability Impact,
we are of the view that the current law
does not generally require a generalinsurer to use investment powers to Invest
for Sustainability Impact.

(a) Systemic risk. A director’s mandatary’s
duty requires him/her to act to increase
shareholders’ interest, which may require
him/her to use investment power toprevent systemic sustainability risk which
could materialise in future and cause amaterial adverse effect on the company.
However, a director has broad discretionin deciding whether any action is for theinterest of the company, which would
allow the director to take a range of

2.4.9

However, the duty of a general insurer’s
director owed to the company also needs
to be considered especially when Investingfor Sustainability Impact is detrimental to

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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the shareholders’ interest at least in the
short term. As stated in 2.4.5, a director
is required to act to promote the interestsof shareholders but such interests do
not necessarily need to be realized in
the short term and long-term interests
can be pursued. Also, while a company
is an entity for profit, not charity, caselaw53 allows a director to make donations
which answer to the expectation of thesociety and are in an amount appropriate
for the size and financial condition of
the company and the recipient. Given
all these factors, we are of the view thata director may use investment power toInvest for Sustainability Impact (ultimateends IFSI) which could be detrimental
to the interest of shareholders if suchinvestment is expected by the society(which is increasingly the case given the
spread of support for decisions to Invest
for Sustainability Impact in Japan) andany financial detriment to shareholders
is appropriate in size. Investing for
Sustainability Impact which is not expected
to be detrimental to the financial interestsof shareholders is also permissible.
Life insurance: Legal requirements to use investment
powers to Invest for Sustainability Impact
2.4.10 Discussion in 2.4.6 above for generalinsurers will equally apply to life insurers.
Once the directors of a life insurer havedecided that climate change or any othersustainability factor is a material risk tofinancial return of its portfolio, they willthen have a duty to decide what, if any,action to take and act accordingly.
Options can include instrumental IFSI
where it can provide an effective way ofaddressing the risk.

360

Life insurance: Legal freedom to use investment
powers to Invest for Sustainability Impact

ACKNOWLEDGEMENTS

Investments for general accounts

EXECUTIVE SUMMARY

2.4.11 Except for investments made with respect
to insurance where the insurance paymentchanges depending on the result ofinvestment, such as IRLIs (regarding which
we discuss in 2.4.12 below), discussion
in 2.4.7 through 2.4.9 above for generalinsurers will equally apply to life insurers.
Investments for special accounts
2.4.12 A life insurer is required to segregate
assets invested for insurance products
where the insurance payment changes
depending on the results of investment
in a special account54 (Special AccountInsurance). For Special Account Insurance,
investment made by a life insurer
directly impacts the payment madeto a policyholder. Also, a life insurer
is required to disclose investment
policy for Special Account Insurance
in disclosure documents delivered topolicyholders55. Given that, a life insurer’s
main mandatary’s duty with respect toinvestment owed to holders of Special
Account Insurance is to achieve thebest possible investment return basedon the disclosed investment policy. The
discussion set out in 2.3.6 will equally
apply to a life insurer with respect toinvestments made for Special AccountInsurance: the life insurer can Invest
for Sustainability Impact where the life
insurer reasonably believes investment
returns: (a) will not be jeopardized (a“tie-break” situation); or (b) will beenhanced over the middle to long term
(but during the life of the policy), even if
it compromises investment return in the
short term.56

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJAPANCONTENTSFOREWORDSINTRODUCTION

3.

ASSET OWNERS’ USE OF THEIR POSITION TO ENGAGE IN STEWARDSHIP ACTIVITIES TO SECURESUSTAINABILITY IMPACT

3.1

The following section considers theextent to which, and on what basis, eachtype of Asset Owner is (a) required or (b)permitted or able to use its position to
influence enterprises in which it invests
by engaging in stewardship activities
designed to achieve positive sustainability
outcomes and minimise negative
sustainability outcomes.

While, in our view, the Asset Owner
may not legally obliged only in specificcircumstances to collaborate with otherinvestors in stewardship activities 9see
instrumental IFSI above), the Asset Owneris in any case permitted to do so given its
costs to benefits ratio.
3.1.3

General
3.1.1

3.1.2

361

In general, an Asset Owner’s investment
duties and powers regarding stewardship
activities are determined by the sameconsiderations set out at in the “Overview
of investment duties and powers” in section 2for each Asset Owner, plus any additionalrules specific to stewardship activities. In
many cases there will be more flexibility
for an Asset Owner to secure sustainability
impact through stewardship activities
than through investment or divestment
because engagement activities are muchless concerned with the composition of aninvestment portfolio, and more with how
an investor uses its position as an investor.
However, where the engagement activities
of a single Asset Owner on its own isunlikely to result in any material change
in the activities of the relevant enterprise(with positive Sustainability Impact orotherwise), it may be challenging for the
Asset Owner to demonstrate that the costs
involved in addressing such Sustainability
Impact issue are justifiable since theAsset Owner is prohibited from incurring
unjustifiable costs due to the mandatary’s
duty owed to the Beneficiaries. Thisissue can be mitigated if the Asset
Owner collaborates with other investors.

Japanese regulators appear to consider
some degree of collaboration between
investors to be possible and desirable,
particularly in relation to stewardship
activities. For example:(a) the Stewardship Code, to which many
Relevant Investors are signatories, statesthat “when an institutional investor
engages an investee company, it may
do so alone but if necessary, it could be
beneficial to engage in collaboration withother institutional investors (collective
engagement)”57; and(b) the FSA published its view that normal
stewardship activities which do notentail agreement on the exercise ofshareholders’ rights with other investors
will not be regarded as collaborating
if investors are acting in concert inthe context of the large shareholding
disclosure rule and TOB58.
3.1.4

However, there are several issues which may
cause a Relevant Investor to be cautious
when collaborating with other investors(discussed below). We are of the view thatnone of them would completely prohibit
collaboration, but they could restrict theextent to which a Relevant Investor may
collaborate with other investors.

that is anti-competitive, it may breachcompetition law59, although that is highly
unlikely to happen in the context ofcollective engagement.
(b) Market abuse. For example, an investor’s
intention in relation to listed shares could
be deemed price-sensitive information. If
a Relevant Investor knows such intention
through collective engagement anddisseminates such information or trades
shares on such information, the Relevant
Investor could be regarded as breaching
the market-abuse rule, punishable by civil
or criminal sanction60.
(c) Disclosure rule. If a Relevant Investor isdeemed as acting in concert with otherinvestors through collective engagement,
their shareholding will be aggregatedand may trigger the filing of a large
shareholding report61.
(d) TOB. If a Relevant Investor is deemed as
acting in concert with other investors
through collective engagement, it maytrigger a mandatory takeover offer or
infringe restrictions in place duringcertain periods62.
(e) Industry-specific change in control rules. For
example, if a Relevant Investor is acting
in concert with other investor throughcollective engagement with an FSA-regulatedcompany, it may trigger a requirement for
regulatory approval or filing63.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES(a) Competition law. If a collaboration involves
the exchange of information or thecoordination of commercial activities
Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJAPANCONTENTSFOREWORDSINTRODUCTION

Pension funds

3.2(c) engage with a broad range of parties,
not just investee companies and index
providers, in order to promote sustainablegrowth of the market67; andLegal requirements to engage for
Sustainability Impact
GPIF (National Pension and Welfare Pension Insurance)
3.2.1

As with the position with respect toinvestment or divestment set out in 2.2.9,
currently there are no legal requirements
directly or indirectly requiring GPIF to
engage for Sustainability Impact.

As with the position with respect toinvestment or divestment set out in 2.2.10,
currently there are no legal requirements
directly or indirectly requiring mutual aid
associations, or employer or DB Plan funds
to engage for Sustainability Impact.

Legal freedom to engage for Sustainability Impact
GPIF (National Pension and Welfare Pension Insurance)
3.2.3

3.2.4

3.2.5

362

3.2.6

GPIF provides “Stewardship Principles”64,
which an Investment Manager appointed
by GPIF must comply (or explain if notcomplying), which require the Investment
Manager to:(b) make the content and quality of
stewardship activities, including
engagement, increase risk-adjusted returnfrom a long-term perspective and avoid“short termism”66;

In its “Policy to Fulfil StewardshipResponsibilities”69, GPIF notes thatconsideration of ESG factors will increaserisk-adjusted return in long term70. Thissuggests that GPIF views engagement
for Sustainability Impact as a tool toincrease financial return (instrumental
IFSI) and does not expect to engage in
Sustainability Impact for its own purpose(i.e., disregarding financial return).

3.3.3

Mutual aid association (Welfare Pension Insurance) andemployer / DB Plan fund (DB Plan)

While we are of the view that the duties of
GPIF are flexible enough to allow GPIF to
engage for Sustainability Impact in certain
circumstances due to the reasons set out
in 2.2.11, we expect that GPIF generally
does not engage in stewardship activities
by itself since it does not directly holdindividual shares.

(a) become a Stewardship Code and United
Nations Principles for Responsible
Investment signatory65;

3.3.2(d) set goals for important ESG issues andproactively engage68.

Mutual aid association (Welfare Pension Insurance) andemployer / DB Plan fund (DB Plan)
3.2.2

Legal freedom to engage for Sustainability Impact

3.3

As with GPIF, though we expect thatmutual aid associations and employer or
DB Plan funds generally do not engage
directly in stewardship activities since such
entities do not directly hold individual
shares, we are of the view that the duties ofmutual aid associations and employer andDB Plan funds are flexible enough to allow
them to engage for Sustainability Impact
in certain circumstances. Engagement
for Sustainability Impact which is likely
to increase financial return will bepermissible, while the law is not clear
if engagement which is detrimental tofinancial return is also permissible, which
would make plans less likely to engage for
Sustainability Impact.
Mutual funds

Legal requirements to engage for Sustainability Impact
3.3.1

For the reasons set out in 2.3.5, we areof the view that the current law does not
generally require an ITM to engage for
Sustainability Impact.

3.3.4

Due to an ITM’s mandatary’ duty as
set out in 2.3.6 (a), the ITM can engage
for Sustainability Impact where theITM reasonably believes it will lead toachieving a higher investment returnin the middle to long term (but during
the life of the investment trust) by
maintaining or enhancing the corporate
value of investee companies that are heldin the portfolio, even if it compromises
investment return in the short term.
Many ITMs are signatories to the
Stewardship Code. The Code requires
an Asset Owner to report annually
to beneficiaries on its plan to fulfil
stewardship duties and the activities
it has undertaken to implement suchplan. In our view, the language of theCode suggests a focus on stewardshipto enhance returns, but maintains
flexibility to engage for Sustainable
Impact. For example, the Code statesthat “an institutional investor should increase
mid- to long-term investment return for clientsand beneficiaries by prompting increases in
the corporate value and sustainable growthof an investee company through a deep
understanding of such investee company andits business environment and constructive“purposeful dialogue” (engagement) based on
consideration of sustainability (mid- to longterm sustainability including ESG elements)
based on its investment strategy”71 (emphasis
added). This ties engagement to longterm financial return to beneficiaries,
but clearly recognises the positive
Sustainability Impact of doing so.
However, the extent to which
Sustainability Impact can be considered
will remain subject to general law, andthere are other parts of the Code which

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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place emphasis on stewardship based on
the interests and needs of Beneficiaries.
For example, the Code provides:(a) an Asset Owner should prompt theInvestment Manager to conduct effective
stewardship activities based on the viewof the ultimate beneficiaries and for theirinterests in accordance with its size andcapability72; and(b) an institutional investor should act primarily
for the benefit of clients and beneficiaries73.
3.4

Insurance undertakings

General insurance: Legal requirements to engage for
Sustainability Impact
3.4.1

For the reasons set out in 2.4.6, we areof the view that the current law does not
generally require a general insurer toengage for Sustainability Impact.

Life insurance: Legal requirements to engage for
Sustainability Impact

ACKNOWLEDGEMENTS

3.4.3

EXECUTIVE SUMMARY

The position for general insurers set out in
3.4.1 equally applies to life insurers.

Life insurance: Legal freedom to engage for
Sustainability Impact
3.4.4

The position for general insurers set out in
3.4.2 equally applies to life insurers.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

General insurance: Legal freedom to engage for
Sustainability Impact

Australia

3.4.2

Canada363

A general insurer has great flexibility toengage for Sustainability Impact since they
will finance the cost involved from theirown assets and it is unlikely that the issue
of engagement will have been addressedin policyholder documentation. However,the costs involved in engagement for
Sustainability Impact must be justifiable
since the general insurer may not incur
unjustifiable costs due to the mandatary’s
duty owed to the Beneficiaries (i.e.
shareholders). The stewardship would not be
detrimental to the interest of shareholders
provided the detriment is “appropriate”
in size and the stewardship activities are
expected by the society, which we believe
they are. In addition, many general insurers
are signatories to the Stewardship Code andthe discussion set out in 3.3.3 and 3.3.4 for
the Code applies to a general insurer.

BrazilChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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4.

ASSET OWNERS’ ENGAGEMENT IN PUBLIC POLICY WORK TO SECURE SUSTAINABILITY IMPACT

4.1

The following section considers theextent to which, and on what basis, eachtype of Asset Owner is (a) required or (b)permitted or able to use its position to
engage in public policy work designed toachieve positive sustainability outcomesand minimise negative sustainability
outcomes, for example, where these are
relevant to the value of portfolio assets.

4.2

Pension funds

4.2.1

Similar to the position with respect toinvestment or divestment set out in 2.2.9,
currently there are no legal requirements
directly or indirectly requiring GPIF,
mutual aid associations, or employer or
DB Plan funds to engage in public policy
work to secure Sustainability Impact.

4.2.2

4.2.3

364

Much like stewardship discussed in 3
above, because policy engagement is muchless concerned with the composition of aninvestment portfolio, and more concernedwith how an investor uses its position as
an investor, there is more flexibility insome cases to pursue Sustainability Impact
through policy engagement activities than
through investment/divestment decisions,although there is a limit as discussed in
3.2.5 and 3.2.6.
Policy engagement must not create
conflicts of interests with the
Beneficiaries. Also, costs involved inpolicy engagement must be justifiable.
As discussed for stewardship in 3 above,
collaboration with other Asset Owners
will help, perhaps through industry bodies
such as the Pension Fund Association.

4.3

Mutual funds

4.3.1

Similar to the position with respect toinvestment or divestment set out in
2.3.5, we are of the view that the current
law does not generally require an ITM
to engage in public policy work for
Sustainability Impact.

4.3.2

There is no explicit prohibition on an
ITM engaging in public policy work, but
it must act consistently with investment
objectives and avoid conflicts of interests.
Also, costs involved in policy engagement
must be justifiable. As discussed forstewardship in 3 above, collaboration withother Asset Owners will help, perhaps
through industry bodies such as theInvestment Trusts Association.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

4.4

Insurance undertakings

Australia

4.4.1

Similar to the position with respect toinvestment or divestment set out in 2.4.6
and 2.4.10, we are of the view that thecurrent law does not generally require
an insurer to use investment powers
to engage in public policy work for
Sustainability Impact.

BrazilAn insurer has great flexibility to engage
in public policy work for Sustainability
Impact, since they will finance the cost
involved from their own assets and isunlikely that the issue of engagementin public policy work will have beenaddressed in policyholder documentation.
However, an insurer must avoid conflictsof interests and the costs involved inengagement in public policy work for
Sustainability Impact must be justifiable
since the insurer must not incur
unjustifiable costs due to the
mandatary’s duty owed to the
Beneficiaries (shareholders).

Japan

4.4.2

CanadaChina

European Union
FranceNetherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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5.

ESTABLISHING NEW FUNDS TO INVEST FOR SUSTAINABILITY IMPACT AND AMENDING THE
TERMS OF EXISTING ONES

5.1

The following section considers the extent
to which it is possible for an Asset Owner
to set up a fund, policy, or other productwith the express objective of Investing for
Sustainability Impact.

5.2

DC Plan
5.2.4

Pension funds

National Pension and Welfare Pension Insurance
5.2.1

National Pension and Welfare Pension
Insurance are established by statuteand GPIF and mutual aid associations
cannot set up new “funds” or amend thestatutory terms of the National Pension or
Welfare Pension Insurance.

DB Plan
5.2.2

5.2.3

365

While there is no explicit prohibition on
setting up a new DB Plan with express
Sustainability Impact objectives, it isunprecedented and it may be practicallydifficult if the Sustainability Impact
objective could result in a significant
reduction in investment return since
we understand that, to date, financial
products in Japan with Sustainability
Impact objectives are expected to pursue
Sustainability Impact to the extent it
is good for investment return and theregulator might not welcome such plan.
If the Sustainability Impact objective is
not expected to be a significant reduction
in investment return, a new DB Plan withsuch Sustainability Impact objective could
be permissible.
Although theoretically possible, it will bepractically difficult to amend the termsof an existing DB Plan to incorporate a
Sustainability Impact objective because
the amendment requires the consent of amajority of participants.

5.2.5

For a DC Plan, an operator (i.e., an
employer and NPFA) must provide 3 to35 “investment options” (i.e., financial
products into which the pension
premiums will be invested) from which aparticipant selects to invest the pension
premiums. An operator may provide
a default investment option, which aparticipant is deemed to have selected if
such participant did not select investment
options of its choice within a specified
period. While there is no explicit
prohibition on setting up an investment
option with express Sustainability Impact
objectives, it may be practically difficult
if the Sustainability Impact objective
could result in a significant reduction in
investment return since we understandthat to date financial products in Japan
with Sustainability Impact objective
are expected to pursue Sustainability
Impact to the extent it is good forinvestment return and the regulator
might not welcome such product. If the
Sustainability Impact objective is notexpected to be a significant reduction
in investment return, an investment
option with such Sustainability Impact
objective would be permissible. Also, itwill be difficult for a DC Plan operator
to select an investment option withexpress Sustainability Impact objectives
as a default investment option since therelevant rule requires the operator toprovide a default investment option basedon investment return.
It is possible to amend the terms ofan investment option to incorporate
Sustainability Impact objectives but, given

the required process (depending on thetype of investment option but at least
the consent of participants is required),
it is likely to be more straight forward
to create a new investment option thanamending existing terms.
Duties on those designing, manufacturing, andproviding pensions
5.2.6

5.3

An operator of a DC Plan must provide
3 to 35 investment options but it is not
required to offer an investment option
with Sustainability Impact objectives.
Mutual funds

Establishing a new investment trust
5.3.1

An investment trust is set up forinvestment return so Sustainability
Impact cannot be the sole objective of
an investment trust but can be pursued
in addition to investment return. There
are several investment trusts with
Sustainability Impact objectives, but weunderstand that all of them are set upon the understanding that Sustainability
Impact is good for investment returnand it will be challenging to set up an
investment trust with Sustainability
Impact objectives which could
significantly reduce investment return,
although there is no explicit prohibition.

Amending an existing investment trust
5.3.2

Investment objectives or investment
policies of an investment trust may beamended but, given the requirements
for amendment, it is likely to be morestraightforward to establish a newinvestment trust than amending existingterms. Amendment to investment
objectives or investment policies will

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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constitute material amendments to thetrust agreement, which require consent
by two thirds of voting rights (each unit
carries one voting right) and objecting
unitholders can demand the buyback of
their units74.
Duties on those designing, manufacturing, andproviding mutual funds
5.3.3

5.4

There is no product governance regime inJapan requiring those who design, create,
and/or operate investment trusts to do
so by reference to the needs of a “target
market”, although the public disclosure
document for an investment trust isreviewed by the FSA in advance and theregulator may look to the need of themarket in review. Given that Investingfor Sustainability Impact is expectedby society in Japan, the FSA would be
more likely to find an Investing for
Sustainability Impact products to meet theneeds of the market.
Life insurance products

5.4.2

Amending an existing insurance product
Theoretically it is possible to amend policy
documents to incorporate a Sustainability
Impact objective, although it requires the
FSA’s approval75.

Duties on those designing, manufacturing, andproviding life insurance
5.4.3

There is no product governance regime inJapan requiring those who design, create,
and/or operate life insurance products to
do so by reference to the needs of a “target
market”, although a new insurance
product needs to be approved by the FSA
and the FSA may look to the need of themarket in review. Given that Investingfor Sustainability Impact is expectedby society in Japan, the FSA would be
more likely to find an Investing for
Sustainability Impact products to meet theneeds of the market.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaEstablishing a new insurance product

China

5.4.1

European Union

366

It seems theoretically possible to create
a new IRLIs with Sustainability Impact
objectives since there is no explicit
prohibition. However, it is unprecedented
and it will be challenging to create an
IRLI with Sustainability Impact objectives
which could significantly reduceinvestment return because the FSA may
think it is not for consumer’s benefit inreview of the product. If the Sustainability
Impact objective is not expected to bea significant reduction in investment
return, an IRLI with such Sustainability
Impact objective could be permissible.

FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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6.

INVESTMENT MANAGERS’ DUTIES TO INVEST FOR SUSTAINABILITY IMPACT

6.1

This section considers the extent towhich, and in what circumstances, an
Investment Manager is (a) legally requiredor (b) legally permitted to Invest for
Sustainability Impact on behalf of an Asset
Owner or otherwise, in each of the three
ways contemplated in sections 2-4.

6.1.1

6.2

6.2.1

(a) the terms of an investment managementagreement (IMA) with an Asset Owner. An
IMA typically provides:
investment objective(s) against
which the Investment Manager’s
performance will be assessed;

6.2.2(ii) any investment strategy specified by
the Asset Owner;(iii) any investment restrictions(e.g., asset class);(iv) the Investment Manager’s contractual
duty of loyalty owed to the Asset Owner;(b) the relevant laws and regulations, inparticular the FIEA, which provides,
among other things:(i)duty of loyalty and duty of care owed
to a client76; and(ii) prohibition on various activities
including self-trading, trades
between the assets it manages, loss
compensation, unjustifiable trade
aimed at benefits for itself or a third
party, and trade on abnormal terms
detrimental to beneficiaries77; andPublic policy work to achieve Sustainability Impact
6.2.5

Powers of investment and divestment

An Investment Manager’s investment
duties and powers are set out by:(i)Legal obligations with respect to
Sustainability Impact

6.2.3

If the IMA provides Investing for Sustainability
Impact as an investment objective, theInvestment Manager is required to makeinvestments in accordance with such objective.
The Investment Manager will be put in adifficult position to balance such objective,
which is difficult to measure financially, andany other (presumably all financial-return
related) investment objective(s).
If the IMA is silent on Investing for
Sustainability Impact, the Investment
Manager will not be legally required toInvest for Sustainability Impact. The
suitability rule under the FIEA79 requires
the Investment Manager to ascertain the
Asset Owner’s investment objective but notits intention for Investing for Sustainability
Impact particularly.
If the Asset Owner wishes the Investment
Manager to Invest for Sustainability
Impact, such objective should be spelled
out in the IMA.

Engagement to achieve Sustainability Impact
6.2.4

As with powers of investments anddivestments, if the IMA is silent on
Sustainability Impact, the Investment
Manager is not legally required to engage
with investee companies to achieve
Sustainability Impact.

6.3

As with powers of investment anddivestment if the IMA is silent on
Sustainability Impact, the Investment
Manager is not legally required toengage in public policy work to achieve
Sustainability Impact.
Legal freedom to Invest for
Sustainability Impact

Powers of investment and divestment
6.3.1

6.3.2

There is no explicit prohibition on an
Investment Manager using powers
of investment and divestment for
Sustainability Impact. However, if the IMA
is silent on Investing for Sustainability
Impact, a financial-return-based objective
will make the Investment Manager
hesitant to Invest for Sustainability Impact
for a fear of a claim by the Asset Owner if
the outcome is reduced returns.
The Investment Manager and the Asset
Owner can agree to amend the IMA to
include Investment for Sustainability
Impact as an investment objective
subject to the Asset Owner’s duty owed to
the Beneficiaries.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY(c) the mandatary’s duty under the Civil Code78.
REFERENCES

367

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Engagement to achieve Sustainability Impact

Public policy work to achieve Sustainability Impact

6.3.3

6.3.6

6.3.4

6.3.5

Since stewardship activities do not have a
direct bearing on portfolio composition,
there will be more room to pursue
Sustainability Impact through stewardship
activities. Additionally, the Stewardship
Code encourages an institutional investor
to appropriately grasp an investee
company’s situation (including risks
related to social and environmental issues
and profit opportunities) to enhance thecorporate value and capital efficiency of
the investee company from the mid- tolong-term perspective and appropriately
perform its stewardship duty for its
sustainable growth80.
However, the Investment Manager mustensure that stewardship activities arein the best interest of the Asset Owner(which mean that the stewardship
activities will not cause financial
detriment to the portfolio) and avoid
causing conflicts of interests between the
Asset Owner and itself or other clients.
Also, unless it is financed from its
own assets, the costs for stewardship
activities must be balanced with benefits.
Collaboration with other investors may
reduce such costs, which the Stewardship
Code suggests.

An Investment Manager is generally free
to engage in public policy work financedout of the Investment Manager’s own
resources rather than being charged toclient portfolios so long as (a) its directors
reasonably believe that it is the bestinterest of the Investment Manager (pleaserefer to discussion in 2.4.9) and (b) it does
not cause conflicts of interests between
the Asset Owner and itself or other clients.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

368

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJAPANCONTENTSFOREWORDSINTRODUCTION

7.

LEGAL LIABILITY TO THIRD PARTIES FOR THE NEGATIVE SUSTAINABILITY IMPACT OF
ENTERPRISES IN WHICH PORTFOLIOS ARE INVESTED

7.1

This section considers the extent to which,regardless of the legal rules under which itis required to operate and its constitution,
an Asset Owner could be legally liable tothird parties for the negative Sustainability
Impact of enterprises in which it invests,
and whether an Investment Manager could
also be liable because of its role in assisting
the Asset Owner to invest in the relevant
enterprise and steward its investment.

7.2

Asset owners

7.2.1

The basic rule is that an Asset Owner
will not be liable to a person damagedby negative Sustainability Impact of aninvestee company, which has a separate
judicial personality from the Asset Owner.

7.2.2

It is theoretically possible that an Asset
Owner owes tort liability to a person
damaged by negative Sustainability Impactof an investee company especially if theAsset Owner is a parent or a controllingshareholder of the investee company as
discussed below.

(a) General Tort Liability. If a parent proactively
prompts a subsidiary to commit a tort,
the parent could be liable to a third party
damaged by the subsidiary. However, tosucceed on this claim, the third party
must establish, among other things, thatthe damage was caused by the parent’s
wilful misconduct or negligence andthe amount of damage and causation
between the parent’s wilful misconduct ornegligent act and the damage, which arevery difficult to prove.
(b) Piercing the Corporate Veil. Case law81 admits
a shareholder’s liability when a company’s
legal personality is abused to avoid
the application of law or the company
369

is totally dormant. This “piercing thecorporate veil” theory can be used fora parent’s liability to its subsidiary’s
creditor. However, in the context ofinvestment by an Asset Owner, which isan institutional investor, the applicabilityof this theory is highly questionable.
7.3

Investment managers

7.3.1

The basic rule is that an Investment
Manager will not be liable for a person
damaged by negative Sustainability
Impact of an investee company, which has
a separate judicial personality from theInvestment Manager.

7.3.2

The discussion set out in 7.2.2 for an
Asset Owner generally applies to an
Investment Manager and it is theoreticallypossible that an Investment Manager
owes tort liability to a person damagedby negative Sustainability Impact of aninvestee company. However, given thatan Investment Manager is not an Asset
Owner, such liability is far more remote
for an Investment Manager than for an
Asset Owner.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJAPANCONTENTSFOREWORDSINTRODUCTION

8.

THE GROWING IMPORTANCE OF TAKING ACCOUNT OF ESG AND SUSTAINABILITY FACTORSWHERE THESE ARE ‘FINANCIALLY MATERIAL’

8.1

It has become increasingly importantfor Asset Owners and their managers totake ESG and sustainability factors into
account in managing portfolios because of
the way in which they could be material
to achieving the financial investment
objectives of the Relevant Investor inaccordance with their legal duties. The
main reasons are summarised below.

8.1.1

Globalisation and change to social
structure led to various social issues
coming to the surface and theenvironment surrounding corporations
changing such as heightened climatechange risk, consumers heightenedinterest in environmental issues, theyounger generation’s aspiration tocontribute to the society when selecting
jobs, and strengthened supply chain
management involving trading partners.
As a result, for the sustainable growth of
an investee company and evaluation ofand investment decisions based on mid- tolong term corporate value, ESG factors
become important in addition to financial
elements. Given this background, theRelevant Investor needs to take ESG
factors into account for investments toincrease investment return82.

8.2

Financially materiality

8.2.1

Because of the growing importance oftaking ESG and sustainability factors
into account in the investment process
where financially material, it is importantto understand how the law defines

what is ‘financially material’ and theperiod by reference to which financial
materiality must be measured. Taking
account of these factors in order to pursue
financial objectives may incidentally have
Sustainability Impacts and may also be
consistent with Investing for Sustainability
Impact. However, beyond that point, any
attempt to realise positive Sustainability
Impact might need to rely solely upon
Investing for Sustainability Impact (i.e.,
because it would no longer be driven by theneed to generate financial performance).
8.2.2

As set out in 1.3.5, a Relevant Investor
is required to consider ESG factors in
its investment decisions where they arefinancially material to the performanceof the investment, balancing returns
against risks.

should be judged, but we are of the viewthat financial materiality can be determinedon a mid- to long-term basis and not juston a short-term basis. Precisely how longdepends on the type of product and thetypical investment horizon of the portfolio
or length of time beneficiaries are typicallyinvested: i.e. financial materiality only
covers risks to financial return which mightmaterialise over the typical investment
horizon and another concept (e.g. Investingfor Sustainability Impact to address
systematic risks) will be required to justify
investing to avoid longer-term risks thatwould materialises beyond that time frame.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilHowever, it is challenging for a
Relevant Investor to evaluate financial
materiality of an ESG factor since theunderstanding of the full financial impact
of environmental, social and governancerisks, and how to measure them, is stilldeveloping. Also, there is no law or official
guidance on the level of significance thatis necessary for an ESG factor to be taken
into account in seeking to secure financial
return in the management of a portfolio.

Canada8.3

Time period by reference to which‘materiality’ is to be assessed

United States

8.3.1

There is no legal standard / definition or
official guidance on the time period byreference to which financial materiality

8.2.3

China

European Union
FranceJapan

Netherlands

South Africa
United Kingdom

GLOSSARY

KANAGAWA
INTERNATIONALLAW OFFICEREFERENCES

Shinsuke Kobayashi
370

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGJAPANCONTENTSFOREWORDSINTRODUCTION
1

If there is an express sustainability objective, respective asset owners
are under a duty to both, instrumental and ultimate ends, IFSI.

2

Article 42 of the FIEA.

3

Article 71 of DB Law.

4

Article 44 of DC Law.

5

Page 625 of the Vol. 24 of the Supreme Court Civil Case Casebook.

6

Tokyo District Court 17 December 1997.

7

Article 9 and 10 of Welfare Pension Insurance Law.

8

Article 3 of Government Pension Investment Fund Law(the GPIF Law).

9

Article 11, Provision 1 of the GPIF Law.

10Article 11, Provision 2 of the GPIF Law.

11

Article 21 of the GPIF Law.

12

Section 1, Item 1 of the Basic Guideline.

13

Section 3, Item 12 of the Basic Guideline.

14

Section 3, Article1, Provision (1), Item (i) of the Mid-Term Goals.

15

Section 3, Article 3, Provision (1) of the Mid-Term Goals.

16

Section 3, Article 7, Provision (1) of the Mid-Term Goals.

17

Section 3, Article 7, Provision (2) of the Mid-Term Goals.

18

Article 644 of the Civil Code.

19

Article 79-3, Provision 1 of the Welfare Pension Insurance Law.

20

Article 35-3, Provision 6 of the Federation of National Service
Personnel Mutual Aid Law.

21

Article 9-3, Provision 1 of the Enforcement Order of the Federation of
National Service Personnel Mutual Aid Law.

22

Section 1, Item 1 of the Basic Guideline.

23

Section 3, Item 12 of the Basic Guideline.

24

Chapter 1, Section 1 of the Welfare Pension Insurance Benefit
Reserve Management and Investment Policy.

25

Chapter 2, Section 1 of the Welfare Pension Insurance Benefit
Reserve Management and Investment Policy.

40

Article 13 of the LITIC.

72

Guidance 1-3 regarding Principle 1 of the Code41

Article 14 of the LITIC.

73

Guidance 2-1 regarding Principle 2 of the Code42

Article 42 of the FIEA.

74

Article 17 and 18 of the LITIC

43

Article 42-2 of the FIEA.

75

Article 123, Provision 1 and Article 4, Provision 2 of the IBA

44Article 644 of the Civil Code.

76

Article 42 of the FIEA

45

Article 97, Provision 2 of the IBA.

77

Article 42-2 of the FIEA

46

Article 97-2, Provision 2 and 3 of the IBA.

78

Article 644 of the Civil Code47

Article 116 of the IBA.

79

48

Article 130 of the IBA.

Article 40 of the FIEA, Article 38 of the FIEA and Article 117 theenforcement regulation of the FIEA

49

Article 300-2 of the IBA and Article 234-21-2, Item 4 and 8 of theenforcement regulation of the IBA.

80

Principle 3 and Guidance 3-1 to 3-3

8150

Article 37-3 of the FIEA, as applied mutatis mutandis pursuant to
Article 300-2 of the IBA, and Article 234-24 of the enforcement
regulation of the IBA, etc.

For example, Sendai District Court 26 March 1970 and Tokushima
District Court 23 July 1975

82

E.g., Article 1. Item (1) in the Policy to Fulfil StewardshipResponsibilities of GPIF

51

Article 355 of the Companies Act.

52

Article 644 of the Civil Code.

53

For example, Supreme Court 24 June 1970.

54

Article 118, Provision 1 of the IBA.

55

Article 294, Provision 1 of the IBA and the Article 227-2, Provision 3,
Item 6 and 10 of the enforcement regulations of the IBA.

56

E.g., the “ESG Investment Guidelines for Investment by Life Insurance
Companies” states that, since a life insurance company’s businesshas a public nature, the life insurance company should manage
its assets well in consideration of social impact in addition to
profitability, safety, and liquidity. While the Guidelines encourage
member life insurance companies to promote ESG investments(through incorporating ESG elements into investment processes andinvesting in assets featuring ESG) in order to contribute to achievinga sustainable society through asset management, it also refers to
profitability of investment and not setting Investing for Sustainability
Impact as a goal in itself. (https://www.seiho.or.jp/activity/guideline/
pdf/esg.pdf).

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

57

Guidance 4-5 regarding Principle 4 of the Stewardship Code (https://www.fsa.go.jp/en/refer/councils/stewardship/20200324/01.pdf).

European Union

58

Section 2 of the “Clarification of Legal Issues Related to theDevelopment of the Japan’s Stewardship Code” (https://www.fsa.
go.jp/en/refer/councils/stewardship/20140226.pdf).

France59

Article 10, Provision 1 etc. of the Antimonopoly Law.

60

Chapter 6 and Chapter 6-2 of the FIEA.

61

Article 27-23 of the FIEA.

26

Chapter 3, Section 1 of the Welfare Pension Insurance Benefit
Reserve Management and Investment Policy.

27

Chapter 3, Section 5 of the Welfare Pension Insurance Benefit
Reserve Management and Investment Policy.

28

Chapter 5 of the Welfare Pension Insurance Benefit Reserve
Management and Investment Policy.

29

Article 644 of the Civil Code.

62

Article 27-2 of the FIEA.

30

Article 69, Provision 1, Article 70, Provision 1, Article 71 and Article 72of the DB Law.

63

Such as Article 32 of the FIEA, Article 52-2-11 of the Banking Act
and Article 271-3 and 271-10 of the IBA.

31

Article 67 of the DB Law.

64

32

Article 3, Provision (1) of the Guideline.

https://www.gpif.go.jp/en/investment/pdf/stewardship_principles_
and_proxy_voting_principles.pdf

33

Article 644 of the Civil Code.

65

Item (1) and (4) of the Stewardship Principles

34

Section3, Article1, Provision (1), Item (i) of the Mid-Term Goals.

66

Item (3) of the Stewardship Principles

35

Section3, Article7, Provision (2) of the Mid-Term Goals.

67

Item (3) of the Stewardship Principles

36

Section1, Article8 of the mid-term plan.

37

Article 2, Provision 1 of the LITIC.

38

Article 2, Provision 2 of the LITIC.

39

Article 9 of the LITIC and Article 20 of the enforcement regulation of
the LITIC.

371

ACKNOWLEDGEMENTS

68

Item (4) of the Stewardship Principles

69

https://www.gpif.go.jp/en/investment/policy_to_fulfill%20
stewardship_2020.pdf

70Article 1 Item (1) in the Policy to Fulfil Stewardship Responsibilities

71

Guidance 1-1 regarding Principle 1 of the CodeJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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1.

INTRODUCTION

1.1

As discussed in the main body of thereport, the expression ‘Investing for
Sustainability Impact’ (IFSI) does not havea fixed legal meaning, including under
the laws of the Netherlands. Rather,
the expression is used here as a type ofconceptual net to catch any legal duty or
discretion on the part of asset owners or
their investment managers to pursue one
or more sustainability impact objectivesof any sort, whether in order to protect
or enhance the financial performance of
their investments or otherwise.

1.2

This memorandum is based on the legal
framework applicable in the Netherlands
as at 31 January 2021. To a certain extent,
Dutch law in the areas covered by thismemorandum is either made by theEuropean Union or implements European
law. This memorandum considers theway in which EU law applies in the
Netherlands. However, the relevant
provisions of EU law are considered in thereport relating to the EU.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

372

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2.

ASSET OWNERS’ USE OF POWERS OF INVESTMENT AND DIVESTMENT TO INVEST FORSUSTAINABILITY IMPACT

2.1

The following section considers the extent
to which, and in what circumstances, eachtype of asset owner is (a) legally requiredor (b) legally permitted or able to use its
powers of investment and divestment topursue IFSI.
Pension funds

2.2

Types of pension fund covered
2.2.1

2.2.2

The Netherlands has an extensive second
pillar of pension provision operating on afunded basis, alongside the state-run firstpillar operating on a pay-as-you-go basis. The
Netherlands currently houses some of theworld’s largest public pension funds by total
assets.1 These funds and their asset managers
are often seen as leading practice on
integrating ESG factors into their investment
decisions and investment policies.

2.2.3

2.2.4

Broadly, the Dutch pension system
consists of three pillars.

(a) State pension: the basic Dutch statepension under the General Old Age
Pensions Act (Algemene Ouderdomswet
or AOW) is the first pillar, based oncompulsory tax and social security
contributions made by Dutch residents.
(b) Employment-related pension:
occupational/company pensions form
the second pillar and are available toalmost all employees. They are typically
pre-funded by employer and/or employee
contributions, which are subsequently
managed/invested by a pension fund(or agents on their behalf) to yield areturn anticipated to provide a pension
for employees (or their survivors) on
retirement or death.

373(c) Individual pension: as the third pillar,
employees and self-employed persons
can also arrange private pensions
independently without employer
involvement and in addition to the AOW
pension (eg via life insurance or a banksaving scheme).

2.2.5

Where this memorandum considers asset
owners that are pension funds it concerns
those in category (b). We note that theDutch private scheme is in the process of
being overhauled.2 This overhaul should
not adversely affect what is set out below
regarding IFSI. This memorandum does
not address the state pension (category (a))
as this is a pay-as-you-go system.
Individual pensions (category (c)) thatare structured as insurance products
are essentially covered by the insurance
analysis in this memorandum. Those
structured as bank saving schemes are notconsidered further here.
In discussing pension funds in thismemorandum, we use the following
expressions in the way described:• Asset owner: the pension funds (which

are the asset owners).3• Beneficiaries: anyone who is entitled to,or who might receive, a benefit from thepension scheme now or in the future – forexample, members of the pension fund,survivors of members and others who may
receive a benefit in certain circumstances(eg members’ spouses, partners orchildren).
• Investment decision-maker: very broadly,

two sorts of investment decisions are
involved in managing a pension – asset

allocation decisions and specific investment
decisions. The former would typically lie
with the pension fund itself, the latter with
its investment manager (whether in-houseor appointed externally).
Overview of investment duties and powers, and use ofinvestment powers to pursue IFSI
Summary conclusion
2.2.6

Dutch law imposes various obligations
on all investors as to how they may use
their investment powers, with the aimof securing positive social outcomes;
for example, prohibiting investment
in cluster munitions and engaging
in transactions that involve money
laundering. While these are crafted
as restrictions rather than positive
obligations to use investment powers
to bring about a particular result, using
investment powers to realise goals of
this sort would be consistent with IFSI.
However, this is not the only situationin which pension funds may be required
to pursue IFSI. Part I of the report
identifies two basic sorts of investment
objective that would involve IFSI by apension fund: first, where bringing about
a defined sustainability impact goal isincidental to protecting the financial
interests of beneficiaries (which is likely
to be especially relevant where a fundhas beneficiaries with a financial interestin the fund which will crystallise in themedium or long-term - this is defined as
instrumental IFSI); and, second, where
the objective is to achieve a particularsustainability impact as an end in itself(defined as ultimate-ends IFSI). Essentially,
while each pension fund would need to

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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consider its own situation, the main duty
that governs the investment of pension
fund assets in the Netherlands is likely
to lead many pension funds to conclude
that they should use their powers ofinvestment and divestment with a view
to pursuing instrumental IFSI. There isalso flexibility under Dutch law to pursue
ultimate-ends IFSI.
Analysis
2.2.7

2.2.8

374

The main governing legislation for Dutch
pension funds is the Dutch Pensions Act(Pensioenwet) and rules and regulations
made under it (the DPA). The prudential
supervisor of Dutch pension funds isthe Dutch Central Bank (De Nederlandsche
Bank N.V. (DNB). A key requirement under
the DPA is that a pension fund must
set its investment policy and invest its
assets in the interest of its participants,
acting in accordance with the so-called‘prudent person rule’. The rule does not
only relate to the investment process,but also to the result. The courts haveestablished that the prudent person rule
gives pension funds the freedom to invest
within the parameters set by the DPA
and the Financial Assessment Frameworkfor Pension Funds (Besluit financieel
toetsingskader pensioenfondsen (FTK Decree)).4
The DPA elaborates upon the basic
prudent person rule. However, it isultimately an ‘open’ standard in the sensethat responsibility for determining andimplementing an investment policy thatis compliant with the prudent person rule
lies primarily with the pension fund.5
Article 135 sub paragraph 1 of the DPA
simply provides that the pension fund must
conduct an investment policy in accordancewith the prudent person rule, based on thefollowing principles in particular:(a) investments must be made in the interestof the beneficiaries having regard totheir entitlements;

disproportionally contribute to addressing
climate issues when compared to the
public at large.9(b) investments in participating companies
are limited to 5 per cent of the portfolio
as a whole and in case the company thatparticipates is part of a group, investmentsin the group are limited to 10 per cent.
When a group of companies contributes toa fund, investments in these participatingcompanies are to be made in considerationof the prudent person rule considering thenecessity of proper diversification;

2.2.12 The FTK Decree attempts to make clear
what is expected in the fund’s investment
policy in the context of the prudent person
rule, leaving fully intact the prudent
person rule itself as an open standard.10(c) investments must be reported on a market
value basis; and(d) further rules to safeguard a prudent
investment policy are to be set by decree.
2.2.9

The loyalty principle requires that thefinancial interests of the beneficiaries areprioritised, although recently there has
been a change in the manner in which
this principle is being fulfilled.6 See
further para. 2.2.29 below on the interplay
between these principles.

2.2.10 Article 135 sub-paragraph 4 of the DPA
further generically prescribes thatpension funds in their management
reports must explain how theinvestment policy takes into account theenvironment, climate, human rights andsocial relationships. There is however noprescriptive norm referenced.7
2.2.11 Recently, a question has been raised in
Dutch literature8 as to whether Article
135 of the DPA could be revised to go
further, thereby in effect stimulating oreven requiring a contribution by pension
funds. Although, while acknowledging
the positive effects of IFSI, this notion
has so far been rejected as it would mean
the pension fund beneficiaries would

2.2.13 Article 13a of the FTK Decree requires
the fund to set a long-term strategic
investment policy in line with thefund’s objectives and policy principles,
including its attitude towards risk, andto demonstrate that this policy and thecorresponding investment plan are inaccordance with the prudent person rule.11
2.2.14 Pursuant to article 18 of the FTK Decree
the fund must establish strategies,
processes and reporting standards toenable the fund both on an individualand consolidated level to monitor therisks to which the pensions that the fundmaintains are exposed, and to permit
the fund to identify, measure, monitor,
manage and report on these risks. Theserisks explicitly include the environment,
climate, human rights and social
relationships regarding the investment
portfolio and the management thereof.
2.2.15 The FTK Decree further provides that theassets must be invested in such a mannerthat the safety, quality, liquidity andreturns of the portfolio as a whole aresafeguarded.
2.2.16 Article 145 of the DPA further provides
that the fund must, every three years,
reconsider its statement setting out thefund’s investment principles (which
is a compulsory part of the fund’sannual accounts). Article 29a of theFTK Decree details that this statement
must include the manner in which the

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGNETHERLANDSCONTENTSFOREWORDSINTRODUCTION

investment policy takes into account theenvironment, climate, human rights andsocial relationships.
2.2.17 Also the Pension Code, which wasestablished in 2013 and which sets out bestpractices for the governance of pension
funds, determined by way of a generalstarting position that the boards of pension
funds need to consider the environment,
climate, human rights and social standards,
which was not further elaborated on.
Although the Pension Code is soft law it
has a legal basis in the DPA, pursuant toarticle 33 sub-paragraph 2 of the Pension
Decree and the law on compulsory
vocational pensions. The Pension Code2018 however no longer includes thisgeneral starting position. Instead thepensions funds have entered into the Dutch
Pension Funds Agreement on Responsible
Investment (see below para [xx]) to further
detail their ESG commitments.12
2.2.18 In principle the directors of a pension
fund are subject to the same rules that
apply to directors of companies generally.
However, considering the special natureof their role and specialist expertise thatthese directors are expected to haveregarding investment activities (as set
by the prudent person rule) and theirfiduciary duties under the DPA (including
as may be derived from the duty ofloyalty), it is presumed that the fund andits directors also have a civil duty of carevis-à-vis beneficiaries of the fund.13 The
liability regime for pension fund directors
is tied to the regulatory framework.
The fact that the relevant rules in the
DPA have been followed does however
not mean that liability may not arise.14
Arguably directors of pension funds may
be subject to stricter norms or higher
375

demands may be placed upon them andtheir conduct.15
2.2.19 Liability could arise where the fundhas suffered a loss as a result of aninvestment decision or policy, if it can beshown clearly not to have complied withthe prudent person rule, and thereby
to have fallen short of the standard of
performance that may be expected of anexperienced and knowledgeable pension
fund director who has diligently sought
to discharge his or her task and who canmade seriously blamed (ernstig verwijt) for
his or her conduct. This will in any eventbe the case if the directors have failed toobserve the duty of loyalty. Nonetheless,this is a high hurdle, and it should
not impact the conduct of directors as
regards instrumental IFSI. It may be
more challenging for the directors todemonstrate the same for ultimate-ends
IFSI. However, any assessment of theirconduct would be made by reference tothe prevalence in investment practice, atleast until fairly recently, of investment
approaches based on variations of modern
portfolio theory, which does not cope wellwith the idea that an investor could haveany goal other than achieving a riskadjusted return.
2.2.20 Legal requirements to use investment powers
to pursue IFSI
2.2.21 Pension funds and their investment
managers must comply with certain
general prohibitions under Dutch lawthat restrict their ability to invest. Whilethese are generally not drafted as positive
obligations to bring about an identified
sustainability impact, the purpose of theseprohibitions is generally nonethelessto achieve goals consistent with social
sustainability, for example, to prevent

terrorist activity, tax evasion and thetrade in illegal drugs. In that sense, theuse of investment powers in a way thatcomplies with these requirements would
fall within the definition of IFSI. Examples
include legislation prohibiting investingin companies producing cluster munitions
or in companies based in jurisdictions thatare subject to international sanctions, andlegislation prohibiting transactions thatwould involve money laundering. 16
2.2.22 Looking more specifically at pension
fund investment powers, pension
funds have a high degree of autonomy
to determine their investment policy.
There are no explicit legal requirements
requiring investing for sustainability
impact. However, pursuant to the DPA,
pension funds have the duty to formulate
objectives and principles used in theirdecision-making, accountability, advice
and internal supervision. This includes
the requirement to adopt a longer-term
strategic investment policy in line withthe fund’s objectives and policy principles,
including its attitude to risk, as part ofwhich the fund must also consider theenvironment, climate, human rights
and social relationships (article 18 FTKDecree). The fund must demonstrate thatthe strategic investment policy and theinvestment plan are consistent with theprudent person rule. The potential forsystemic financial or economic collapse isa risk that should be taken into account
while creating an investment policy and it
is generally recognised that, for instance,
fossil fuels-based investment may besusceptible to a carbon valuation bubble
resulting from increased (public) pressure
and the need to execute the energy
transition. The longer-term strategic
investment policy of pension funds in

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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the Netherlands therefore must take into
account the environment, climate, humanrights and social relationships in relation
to the investment portfolio and the
management thereof and consequently
the investments by the fund should bemade accordingly.
2.2.23 Many pension funds are likely to havebeneficiaries with medium- and longerterm financial interests who are more
likely than those with short-term financial
interests to be exposed to the declining
sustainability of the environmental
and social systems on which economic
activity and, hence, financial return
depends – in other words, some of the
key sustainability issues that are thetarget of IFSI. It is clear that the prudent
person rule requires that these issues
are taken into account, as the FTK
Decree identifies each of these, ie theenvironment, climate, human rights andsocial relationships, as risks that must
be considered as part of determining
the long term investment strategy of afund17. In view of the requirement under
the prudent person rule to invest in theinterests of all beneficiaries, pension
funds should consider what, if anything,
they are able to do to reduce the risk
to these beneficiaries, including ESGrelated risks, as also explicitly requiredby the FTK Decree. Having regard to themultiple cohorts of beneficiaries with
their varying financial needs, and theparticular exposure of some of them todeclining sustainability, there are likely
to be situations in which a pension
fund concludes that it needs to pursue
instrumental IFSI in seeking to protect
those longer-term financial needs.

376

2.2.24 What it comes down to in relation to ESG
factors and IFSI in particular is whether
a pension fund will be permitted to cause
short-term financial sacrifices due to its
assessment and evaluation of long-termrisks.18 The prudent person rule affords
the directors of a fund the discretion to
strike a balance between these interests as
the directors may objectively believe to beappropriate, with a view to safeguarding thefuture interests of longer-term beneficiaries.
2.2.25 As explained in the main body of thereport, taking ESG factors into accountdoes not necessarily amount to IFSI (since
it may involve no more than seeking to
avoid short-term financial damage from
ESG risks without pursuing specified
sustainability impact objectives). A pension
scheme may conclude that it needs topursue IFSI rather than simply taking
ESG factors into account if, for example,
an identified sustainability risk affects
many or most potential investees (or thesystem as a whole), so that it is necessary
to change investee behaviour rather
than simply avoiding investing in certain
companies. This might suggest that apension fund should, for example, adopt
investment policies designed to change thebehaviour of actual or potential investees(as well as engaging in stewardship
activities with the same objectives),
provided that it had grounds to consider
that there was a reasonable prospect of its
actions achieving their objective.
2.2.26 In its report on sustainable investmentin the Dutch pension sector19 the DNB
does make the point that the relationshipbetween the ESG performance ofbusinesses (and by extension of aninvestment portfolio comprised ofinvestments in businesses that take ESG

factors into consideration in their businessconduct), and the corresponding risk
return profile in the longer term, needs
further research to better understandany differences compared with a lesssustainable investment policy andcorresponding investments in businesses.
That said, it is apparent also from theaforementioned report of the DNB thatsustainable investment in the Dutch
pension sector, which impacts both thesupervisor’s approach and investing bypension funds (and their investment
managers), is increasingly seen as afinancial opportunity. This is based on thepremise that sustainable investments are
more profitable (and less risky) than nonsustainable ones20 and as stated above, theenvironment, climate, human rights andsocial relationships must be considered bya fund as part of its investment strategy
and are an integral part of the risks thatmust be considered as part of investing inline with the prudent person rule.
2.2.27 However, the size of a pension fund may
in practice result in limitations on theability of the fund to take ESG factors
into account in making investment
decisions: a smaller fund will most
likely be confronted sooner with thelimitations that are imposed by portfolio
diversification requirements. This maylead pension funds to conclude that theyneed to address the risks posed by ESG
factors in other ways, for example byengaging with investees (see section 3
below) or through investor alliances.
2.2.28 While each pension fund would need toconsider its own situation, we anticipate
that many may conclude that they should
use their powers of investment anddivestment to pursue positive sustainability

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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impacts where doing so can reasonably
be expected to help in achieving topursue IFSI. Since individual funds are
not generally able to bring about change
at a system-wide level, perhaps the mostimportant way of pursuing this would
be through various forms of investor
alliance. Particularly as part of a wider
strategy, it may also be possible for anindividual pension fund to seek to address
system-wide challenges by focusing on
the contribution of individual enterprises
to the particular sustainability issue
concerned. When engaging in activities ofthis sort, a pension fund would need to set
an appropriate balance between the needsof beneficiaries with medium- and longerterm interests in the fund, and those withshorter-term interests.
Legal freedom to use investment powers to pursue
IFSI
2.2.29 In essence, because it is an open norm,
the discretion afforded under the prudent
person rule moves and evolves together
with the norm itself, which in turn relies
on investment theory and practice anddevelopments on the financial markets.21
The open and evolving nature of theprudent person rule therefore enables
IFSI (regardless of whether it serves toenhance return or reduce investment risk)
as long as this is being done with a view torealising the (future) pension entitlementsof the beneficiaries.22
2.2.30 The application of IFSI under the prudent
person rule must not be detrimental tothe interests of beneficiaries. This follows
from the loyalty principle.23 However,the loyalty principle does not preclude apension fund from taking into accountnon-financial factors in its investment
policy.24 In addition, the board of a377

pension fund has a degree of flexibility
when it comes to demonstrating thatthe investment policy complies with theprudent person rule.25
2.2.31 There is therefore nothing that prohibits
IFSI, even where the ultimate goal of
doing so does not concern the financial
goals of the portfolio. A pension fundwould however always need to strikea balance in pursuing ultimate-ends
IFSI between the sustainability impact
being sought and meeting its financial
obligations to beneficiaries.
2.2.32 In its report on sustainable investmentin the Dutch pension sector, the DNB
expresses the view that the prudent
person rule does not prevent taking
ESG-factors into consideration when
determining the investment policy ofthe pension fund (rather the contrary).26
It is clear to us that, in the view of the
DNB, sustainability is linked to systemicrisk. Since the DNB is the prudential
supervisor of Dutch pension funds, its
position is clearly significant. The DNB’s
observations specifically refer to pursuing‘sustainable investment policies’ in a waythat distinguishes between that activity
and seeking to achieve the financial goalsof the portfolio.
2.2.33 The DNB has expressly clarified that
it would be a misconception to regard
the following items as limitations
on sustainable investing: (i) therequirement to have adequate control
over investments, including sustainable
investments; (ii) illiquidity – part of theinvestment portfolio may be illiquid
as long as the portfolio has sufficient
diversification and balance; (iii) (higher)
costs of sustainable investing are notunacceptable – although it is recognisedthat the costs associated with an ESG
investment policy may create a hurdle forsmaller funds; and (iv) required additionalown capital due to risks related tosustainable investing. 27
2.2.34 The position of the DNB is consistent
with Article 19(1)(b) of the Second EU
Pensions Directive.28 That provides thatmember states are to allow pension funds
to ‘take into account the potential longterm impact of investment decisions onenvironmental, social, and governancefactors’; it specifically uses the word
‘impact’, and the impact concerned ison environmental and social factors,
with no mention of financial return. The
drafting therefore suggests that longterm environmental and social outcomesof investment decisions can be a factor
in investment decision-making, and thedrafting of the provision does not restrict
this to circumstances where doing so isfor the purpose of securing the financial
interests of pension fund beneficiaries
in the long-term. In other words, atsome level this drafting contemplates
the pursuit of long-term environmental
and social outcomes as ends in theirown right. This also coincides with how
the prudent person rule is interpreted
under the DPA, and the FTD Decree asdetailed above. Pursuant to article 102aof the DPA the board of a pension fund isrequired to record in consultation withthe other governance bodies of the fundthe targets, the policy assumptions andthe risk attitude of the fund. Throughrecording the policy assumptions, targets
and risk attitude of the fund, these bodies
can and should monitor the executionof the pension arrangement as agreed
between the beneficiaries, the relevant
employee and employment organisation

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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and the fund. The relevant bodies include
the supervisory council of the fund, therepresentative body of the fund and thecouncil of interested parties associatedwith the fund. The representative body
includes representatives of the workers andof the employers, as well as beneficiaries ofthe fund and members of the board of thefund. The representative body is entitled
to require the board of the fund to provide
information and may pass judgement on
the conduct by the board. If the fund does
not have a representative body, there may
instead be a council of interested parties
comprised of beneficiaries of the fund,including pensioners, that may provide theboard of the fund with advice and is also
entitled to information, and any changes tothe strategic investment policy of the fundrequire the approval of this body. We notethat the ability of beneficiaries to exercise
influence is limited, also in practice, as
the board of the fund has ultimately theauthority to establish the investment policy
and individual beneficiaries that are partof a collective pension arrangement arecompulsory members of a fund and cannot
leave if they disagree with the fund’s policy
as implemented in practice. We note alsothat in practice, the views of beneficiaries
on how the fund should invest tend to vary
widely, with some participants giving aclear priority to return on investments. The
board of a fund will have to consider thesediffering views.29

378

Observations on investment practices of Dutch
pension funds
2.2.35 Dutch pension funds have in practiceused the autonomy afforded under the
DPA to integrate ESG factors into theirinvestment decisions and have over recent
years proactively developed sustainable
investment policies which, in particularwith the larger pension funds, areintegrated in their investment policy,
resulting in exclusion lists, engagement
strategies, and best-in-class investment
strategies being used. Increasingly thethinking has changed from considering
sustainable investing as a financial risk,
to not investing sustainably being a
reputational risk for the fund considering
its position in society (also given the size of
assets owned), to realising that sustainable
or impact investing may in fact be afinancial opportunity.30 There has also beena clear move towards IFSI where this canhelp to manage medium- to longer-term
systemic risk for pension fund portfolios.
One of the most notable examples of thisis the Dutch Pension Funds Agreement
on Responsible Investment (2018) underwhich a large number of Dutch pension
funds have agreed to cooperate to create amore sustainable society by preventing or
tackling negative consequences for society
and the environment of investments bypension funds. Another example is therecent launch by APG, AustralianSuper,
British Columbia Investment Management
Corporation (BCI) and PGGM of the
Sustainable Development Investments
Asset Owner Platform (SDI AOP).31 The
stated purpose of the platform, whichis available to the market, is to enable
investors to assess companies on theircontribution to the UN Sustainable
Development Goals (SDGs).32

2.2.36 ABP (Stichting Pensioenfonds ABP),
the national civil pension fund forgovernment and education employees,
set itself in 2020 specific sustainable
development goals to be achieved by 2025.
They include (i) that 20 per cent of total
assets under management should go to‘sustainable development investments’(SDIs), (ii) a 40 per cent CO2 reduction in
ABP’s equity portfolio, (iii) the phasingout of investments in coal mines andtar sands, (iv) the investment of €15bn
in renewable and affordable energy, forexample through green bonds, and (v) the
doubling of ‘green building certificate’
real estate assets in APG’s portfolio.
2.2.37 ABP also states in its sustainable andresponsible investment policy that it will
be working towards building consensus
for the abovementioned SDI-standards
among investors.
2.2.38 Another example is the PMT (Stichting
Pensioenfonds Metaal en Techniek) investment
policy which contains, as one of their ten
investment beliefs:“

Only investments that take account of ESG
factors (Environmental, Social, Governance)are profitable in the long term because
adverse consequences of an economic
activity cannot be passed on to people,
society and the environment indefinitely.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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2.2.39 PMT (Stichting Pensioenfonds Metaal en
Techniek) declares that it takes ESG factors
into account in its decision-making around
all investments, ie through measuring
the CO2 footprint of its equity portfolio
and asking companies to report on theiractivities regarding human rights. Unlike
ABP, PMT has not set itself specific goals,
but does commit to creating and enlarging
its awareness of ESG. As instruments
used to operationalise ESG themes, PMT
lists: (i) using its shareholders’ rights andentering into dialogue, (ii) not investing incountries violating international treaties
or products conflicting with the principles
of PMT, and (iii) where possible, not only
avoiding negative ESG consequences ofinvestments, but investing in solutions
to social problems, while maintaining
returns.
2.3

a UCITS has a separate managementcompany, the asset owner can be regarded
as, essentially, a combination of the two.
Where the UCITS is self-managed, theasset owner is the UCITS itself. For the
purposes of this memorandum, the asset
owners in each of these scenarios will bereferred to as UCITS managers.
• Beneficiaries: the current unitholders in

the mutual fund.
• Investment decision-maker: theauthorised UCITS manager or delegatedinvestment manager. Where the authorised
UCITS manager delegates its investment
duties to an investment manager, inprinciple it retains responsibility for theinvestment manager’s decisions.
2.3.3

Mutual funds

Types of mutual fund covered
2.3.1

2.3.2

This memorandum considers the positionof UCITS Directive33 compliant collective
investment schemes regulated by the
Dutch Authority for the Financial Markets(Stichting Autoriteit Financiële Markten (AFM)).
It does not consider alternative investment
funds regulated under the EU Alternative
Investment Fund Managers Directive34(AIFMD), which together with UCITS funds
comprise the two categories of collective
investment schemes regulated under the
Dutch Financial Supervision Act (Wet op
het financieel toezicht) and the rules andregulations made under it (the DFSA).
In discussing mutual funds in thismemorandum, we use the following
expressions in the way described.
• Asset owner: UCITS funds can either be

self-managed or managed by an external/
separate management company. Where379

of terrorist finance). Subject to that,since ultimate ends IFSI is a form ofinvestment objective, it is unlikely thata UCITS manager would be required topursue ultimate ends IFSI where, as is
usually the case at present, the disclosed
investment objectives and policy of the
UCITS, and/or the prospectus of the UCITS,
do not contemplate it. However, a UCITS
manager is certainly permitted and likely
even required to pursue instrumental IFSI
even where it is not contemplated in thedisclosed investment objectives, policy andprospectus of the UCITS, if such would bein furtherance of achieving the disclosed
investment objectives of the UCITS.

Briefly, UCITS are open-ended collective
investment schemes that comply with
the UCITS Directive and are authorisedby the AFM for promotion to retailinvestors (although institutional investors
also invest at scale in UCITS). A UCITS
fund manager must be establishedin the form of a company with legal
personality and should have at least two
directors entrusted with its daily affairs
who perform their duties from theNetherlands. A UCITS manager may, inprinciple, delegate its investment duties toan investment manager, subject to certain
requirements under the DFSA.

2.3.5

2.3.6

Overview of investment duties and powers, and use ofinvestment powers to invest for sustainability impact
Summary conclusion
2.3.4

As with pension funds, there are certain
circumstances in which UCITS managers
are required to use their investment
powers (or refrain from using them) in amanner that is consistent with IFSI (forexample, so as to prevent the laundering

2.3.7

A UCITS manager must generally beauthorised by the AFM in accordancewith the requirements of the DFSA.
Many of the requirements applicable to
UCITS managers under the DFSA stemfrom the Dutch implementation of the
UCITS Directive, as well as from directly
applicable EU legislation.
Under the DFSA, as part of their duty ofcare, UCITS managers are, among otherthings, required to treat unitholders fairly
and act in unitholders’ best interests. TheDFSA does not contain any provisions
limiting this to financial interests. In
principle, it could therefore be taken
to include other kinds of interest (butsee further at paragraph 2.3.12 below).
The DFSA also contains requirements
around investor protection, valuationand disclosure regarding the UCITS’
investment objectives and policies and theassets in which the UCITS may invest.
UCITS managers have a duty to act
in a way that is consistent with theconstitution of the UCITS and its
prospectus, including the fund’s

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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investment objectives. Breaching suchduties can lead to liability for breachof contract, regulatory enforcement
or liability based on an unlawful act(onrechtmatige daad).
2.3.8

2.3.9

UCITS managers can delegate investment
decision-making to investment managers
subject, among other things, to a duty to
exercise due skill, care and diligence indoing so. The UCITS manager nonethelessretains responsibility for compliance with
its general duties under the DFSA.
Certain UCITS may be listed on stock
exchanges as exchange traded funds (ETFs)
and subject to additional requirements ofthe particular exchange on which the ETF
is traded.35

Legal requirements to use investment powers to
pursue IFSI
2.3.10 As with pension funds, certain sorts ofinvestment activity are prohibited in the
Netherlands, such as investment thatwould facilitate money laundering. Using
investment powers in accordance withthis legislation can be regarded as a formof IFSI and our comments at paragraph2.2.21 above apply equally here.
2.3.11 Other than that, there is no general
requirement for UCITS to use theirinvestment powers to pursue IFSI.
2.3.12 We have considered whether the general
duty of care under the DFSA requires a
UCITS manager to pursue sustainability
impact, in particular on the basis that it
is in the interests of beneficiaries. Whileeach fund would need to be consideredon its own terms, unless one of the statedinvestment objectives of the fund isconsistent with IFSI, we do not consider
that it does insofar it concerns ultimate
ends IFSI. The regulatory rules under380

the DFSA on the creation and operationof UCITS funds are highly prescriptive.
In particular, the DFSA imposes detailed
requirements in relation to describing
and disclosing the investment objective
and policy of the UCITS, including in
its prospectus. These features would be
fundamental in determining the scope of
the UCITS manager’s duty to act in theinterests of beneficiaries because they are(and as a regulatory matter are intended
to be) the basis upon which beneficiaries
have invested in the UCITS. Since ultimate
ends IFSI is a form of investment objective,
it is unlikely that a UCITS manager would
be required to use its powers of investment
and divestment to pursue ultimate ends
IFSI where, as is usually the case at present,
the disclosed investment objectives andpolicy of the UCITS do not contemplate it.
This entails that a UCITS manager needs
to disclose its intention to pursue ultimate
ends IFSI in, for instance, the investment
objectives and policy as disclosed.
However, we believe that where thedisclosed investment objectives, policy andprospectus of the UCITS do not contemplate
the pursuit of sustainability impact, theUCITS manager would likely be required
to pursue instrumental IFSI if such would
be instrumental in achieving the disclosed
investment objectives of the UCITS.
Legal freedom to use investment powers to invest forsustainability impact
2.3.13 We have also considered whether thegeneral duty of care under the DFSA
permits a UCITS manager to pursue
sustainability impact.
2.3.14 Were a UCITS manager to seek to pursue
IFSI, it would be essential that it did not
result in any divergence from the statedinvestment objective and policy of the

UCITS. However, subject to that, it is atleast possible that a UCITS manager could
take sustainability impact into account inso-called ‘tie break’ situations (to choose
between two otherwise equal investment
options), or where it is demonstrably
clear that the investors in the UCITS
fund expect it to do so. In considering
its approach, the UCITS manager mightneed to take account of the characteristicsof the fund and, in particular, whether
unitholders are likely to hold units for along period of time and therefore be more
exposed to systemic sustainability risk. 36
2.4

Insurance undertakings

2.4.1

In discussing insurance undertakings inthis memorandum, we use the following
expressions in the way described.
• Asset owner: the insurer.
• Beneficiaries: natural or legal persons

who are entitled to benefit under aninsurance policy issued by the insurer, ie
the insured.
• Investor: means the shareholder of

an insurer.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union• Investment decision-maker: the insurer

Franceor an investment manager appointed by
the insurer.

Japan

Types of insurance undertaking covered

Netherlands

2.4.2

South Africa

A distinction can be made between life
insurance and general/non-life insurance,
briefly outlined below. Where nototherwise specified, references to insurers
in this memorandum refer to both life andnon-life insurers.

General insurance versus life insurance
2.4.3

The concept of general insurance needs
little introduction. In return for thepayment of a premium, the insurer
undertakes to insure against a set ofUnited Kingdom
United States

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specified risks. The policyholder’s objective
is to secure protection from those risks,rather than an investment return (and,in one sense, a policyholder is therefore
not concerned with how premiums areinvested). The insurer’s profit is essentiallythe difference between premiums plus
investment return less its costs and what it
has to pay out to cover claims.
2.4.4

2.4.5

2.4.6

381

Under a life insurance contract, the insurer
undertakes, in consideration of payment ofa premium, either as a single premium or
throughout a specific period, to pay a lumpsum or specified regular income on thedeath of that person, or some other defined
event, for example, contracting a critical
illness. Contract-based pension policies(see paragraph 2.2.4 above) in principle
qualify as life insurance.
There are various sorts of life policies.
Among other things, they may be ‘withprofits’ (also known as ‘participating’),
where the relevant policyholder would beentitled to at least a guaranteed amounton maturity of the policy. Investment
performance is reflected in bonuses that
attach to the policy. Bonuses may bedeclared annually, and final bonuses areadded on maturity. It has become muchless common for insurers to offer policiesof this sort, in part because of the way
investment risk falls on the insurer.
An alternative is unit-linked life
insurance. The predominant, if notalmost exclusive, purpose of this sortof insurance is investment. Relevant
policyholder premiums are used topurchase notional ‘units’ in an investment
fund and returns payable to the relevant
policyholder reflect the performance of
those units. As such, investment risk
falls on the policyholder. Policyholders

select the funds they wish to invest infrom a range available. In reality, theunits are contractual claims under thepolicy against the insurer, the value of
which is calculated by reference to theperformance of an identifiable pool ofassets held within the insurer’s fund ofassets held in connection with its life
assurance business as a whole.

policies, could impose constraints similar
to those discussed above in relation tomutual funds).
Analysis
2.4.8

Overview of investment duties and powers, and use ofinvestment powers to pursue IFSI
Summary conclusion
2.4.7

As with pension funds and mutual
funds, there are certain circumstances inwhich insurers are required to use theirinvestment powers (or refrain from usingthem) in a manner that is consistent withIFSI (for example, so as to prevent thelaundering of terrorist finance). However,this is not the only situation where legal
duties may require IFSI. Essentially, while
each insurer would need to consider
its own situation, we anticipate thatthe duties of directors of insurance
undertakings in the Netherlands maylead them to conclude that the insurer
should use its powers of investment anddivestment with a view to instrumental
IFSI, since this is relevant to achieving
the success of the insurer in the longterm. Indeed, for listed Dutch insurers
this is consistent with the approach of the
Dutch Corporate Governance Code. Since
insurers own their assets as principal,
there is also flexibility for an insurer topursue ultimate-ends IFSI. In each case,the insurer would nonetheless need tocomply with Dutch regulatory capitalrequirements. In addition, the insurer
would need to act in a manner consistent
with the terms of any policies it has
written (which, in the case of existing

2.4.9

An insurance undertaking must be
operated in the form of a legal entity
subject to the Dutch corporate code.37 The
starting point under Dutch corporate law
is that the board of an insurance company
is responsible for determining thestrategy of the company. In doing so theboard must act in the company’s interest(vennootschappelijk belang).38 Although
Dutch law does as such not provide adefinition of the concept of ‘company’s
interest’, according to case law suchinterest should be determined on the basisof the circumstances of the case39, with
an emphasis on the long-term success(bestendige succes) of the company and its
enterprise. In performing their duty to act
in the interest of the company, directors
must also carefully consider the interestsof all relevant stakeholders.40 These areits shareholders, employees, creditors
and in the case of an insurance company,
specifically, its insured persons.
Furthermore, as of 1 December 2019, therules regarding remuneration for listed
entities require an explanation as to how
the management renumeration policy
contributes not only to the company’s
strategy, its long-term interests, but also
to the sustainability of the company.41

2.4.10 The starting point is that premiums paid
to an insurer are assets of the insurer,
to be disposed over as principal, and assuch are at the disposal of the board of
the company for investing with a view toensuring the continuity and long-term
success (bestendige success) of the company,in the interests of the company’s

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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stakeholders. This in principle gives theboard of the insurance company wide
discretion as to how to set the investment
policy, subject to specific regulatory
requirements set out further below.
2.4.11 Recently, in Dutch legal literature a debate
has ensued between authoritative writers
as to whether the legal duty of directors
and supervisory directors of companies
to properly perform their statutory task
should include the legal duty to ensurethat the company operates in a sustainable
manner, accounting for all ESG factors in
the conduct of the company’s business as
part of society.42 The legal writers argued
for a change of law to the effect that thedirectors and supervisory directors in theperformance of their tasks as (supervisory)
directors of the company must take asa guiding principle the conduct of thecompany and the associated enterprise asa responsible company (verantwoordelijke
vennootschap) in society. The second
suggested change concerns the recordingof the company’s purpose in the articles
of association of the company, whereby
its purpose would convey the company’s
voluntary expression of its ultimate goal
and its leading principles. In substance, anargument was made for an express legal
basis for responsible corporate citizenshipand a new contract between the company
and society, whereby the (supervisory)
directors could be held liable for failing toensure compliance. The premise for theargument and the call for amendmentof the law was the claim that Dutch(listed) companies have in recent years
been focused too much on the creationof shareholder value and have become
detached from society. The claim attracted
some attention and opposition.43 Boththe factual and legal premise of the claim
382

where opposed and considered flawed. In
particular in light of the existing Dutch
legal framework as already applicable to(listed) companies. In this legal framework
ESG factors can be and indeed are inpractice part of the consideration of
the board and its supervisory directors
when determining the strategy of thecompany. Also, responsible conduct of
the business is already set as a standard.
This also flows from the Dutch Corporate
Governance Code (the Code).44 The Code in
Principle 1.1.1. expressly identifies decent
and responsible entrepreneurial activity.
See in particular Principle 1.1.1 v and vi
where it regards the long term strategy,
and that this strategy should consider
the interests of stakeholders, employees,social and environmental aspects and the
responsibility in the international(supply) chain.
2.4.12 The Code contains the principles and bestpractices regarding governance which canbe considered as widely supported andgenerally accepted in the Netherlands.
These principles are set out in so called
best practice provisions.
2.4.13 The Code is statutorily anchored in article
2:391, section 5, of the Dutch Civil Code
(DCC) on the basis of which the Code has
been designated by legislative decree as
the code of conduct in respect of which
the board of the company must accountfor in the management report to thefinancial accounts.45
2.4.14 The Code applies to all companies that havetheir statutory seat in the Netherlands
and whose shares are listed on a regulated
market or a comparable system in the
Netherlands or elsewhere.46 The Code isbased on a ‘comply or explain’ approach47:
where the insurer deviates from the Code,it must disclose its reasons for doing so in
its annual board report. The reasons for
deviation should in any event include how
and why the company deviated from theprinciple. If applicable, the board should
also incorporate a description of any
alternative measure that was taken andeither explain how that measure served
the purpose of the principle departed from.
If the departure is of a temporary natureand continues for more than one financial
year, an indication of when the company
intends to comply with the principle again
should be incorporated as well.48 It is forthe general meeting of shareholders toultimately decide whether it agrees with the
explanation for deviations from the Code.49
2.4.15 Principle 1.1 of the Code requires the
management board (monitored by thesupervisory board, as applicable; see
Principle 1.1.2 and 1.1.3) to focus on longterm value creation for the company andits affiliated enterprise. In doing so, themanagement board should formulate astrategy that reflects this focus (Principle
1.1.1). When developing the strategy,
attention should in any event be paid to,inter alia:• the interests of the stakeholders (Principle

1.1.1 section v.); and• any other aspect relevant to the company

and its affiliated enterprise, such as theenvironment, social and employee-related
matters, the chain within which theenterprise operates, respect for humanrights, and fighting corruption andbribery (Principle 1.1.1 section vi.).
2.4.16 By introducing the environment andsocial matters as a relevant aspect in longterm value creation, sustainability has
found its way into the Code. According
to the Monitoring Committee Corporate

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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Governance Code, corporate social
responsibility (maatschappelijk verantwoord
ondernemen) forms an integral part of the
day-to-day operations of a company thataims to create long-term value.50 While
the Code does not impose a binding legal
obligation, its content is seen as reflecting
widely held general views on good
corporate governance (this is emphasisedby the fact that deviation is not possible
without extensive explanation).51
2.4.17 In practice the framework within which
an insurer can exercise its investment
powers is further set by:(a) the terms of the policies it has writtenwith its policyholders (to the extent
those policies contain provisions that are
relevant to the investment process);(b) rules set out in the DFSA (and, where
relevant, the DCC), and(c) duties to observe reasonable careand skill vis-à-vis its clients (ie thepolicyholders) in carrying out its activities
as part of the general duty of care that has
been established for financial institutions
vis-à-vis their clients, in particular in
relation to (complex) financial products.
2.4.18 The applicable rules under Dutch law
will depend, in part, on whether aninsurer is a ‘Solvency-II firm’, a ‘SolvencyII – light firm’ or a ‘non-Solvency-II
firm’. This memorandum only considers
Solvency-II firms.
2.4.19 In the Netherlands, insurers must be
authorised by DNB pursuant to the
DFSA and are regulated by both DNB(for prudential purposes) and AFM (fornon-prudential purposes). Many of therequirements for insurers set out below
stem from the Dutch implementation of
the Solvency II Directive, the Insurance
383

Distribution Directive and Packaged
Retail and Insurance-Based Investment
Products Regulation, as set out in Dutch
implementing legislation (primarily, the
DFSA) as well as other directly applicable
EU regulations (please refer to the EU law
section of this report).52
2.4.20 The DFSA also obliges insurers totake the legal form of a public limited
liability company (naamloze vennootschap),mutual insurance company (onderlinge
waarborgmaatschappij) or European
Company (Societas Europaea or SE). As aconsequence, insurers must also comply
with relevant governance and corporate
law requirements applicable to such
type of legal entities set out in the DCC,
including the Code (as discussed above inpara 2.4.8 et seq.
2.4.21 Similar to pension funds, insurers’
investment powers are primarily governedby a prudent person principle, whichstems from Article 132 of the Solvency-II
Directive53. Article 132 Solvency-II has
been implemented in Dutch law in Section
3:267h of the DFSA in conjunction with
Chapter 12.2 of the Decree on Prudential
Rules (Besluit prudentiële regels Wft).
Pursuant thereto, insurers are required topursue an investment policy in accordancewith the prudent person principle as set
out in Articles 132(2) – 132(4) SolvencyII, taking into account Title I of Chapter
VIII of the Regulation (EU) 2015/35 on thetaking up and pursuit of the business of
Insurance and Reinsurance (Solvency II).54
Essentially, the prudent person principle
requires that:(a) with respect to the whole portfolioof assets, the insurer shall only invest
in assets and instruments whose risks it
can properly identify, measure, monitor,

manage, control and report, and canappropriately take into account in theassessment of its overall solvency needs;(b) all the assets of the insurer are
invested in a manner that ensures the
security, quality, liquidity and profitabilityof the portfolio of assets of the insurer as
a whole;(c) assets held to cover the technicalprovisions are invested (i) in a manner
appropriate to the nature and duration of
the insurance liabilities and (ii) in the bestinterest of all beneficiaries taking into
account any disclosed policy objective;(d) in the case of a conflict of interest,
insurers (or their investment manager)
must ensure that the investment ismade in the best interest of policy holders
and beneficiaries.
(e) As part of the prudent person
principle, Articles 132 paragraphs 3
and 4 Solvency-II set out certain further
requirements in relation to inter alia
benefits provided under an insurance
contract directly linked to the value ofunits in a UCITS or a share index, the useof derivatives, investment in certain typesof assets as well as asset diversification.
2.4.22 Insurers are further subject to the conductof business requirements under the DFSA,
including the duty of care to act honestly,
fairly and professionally in accordancewith the interests of their policyholders.
The DFSA does not define ‘interests’; thisrequirement could therefore in principle
be interpreted as extending beyond
financial interests (but see further below).
2.4.23 Where insurers distribute theirown insurance products, in certain
circumstances, such as where they advise
potential policyholders on the product

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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or provide a personal recommendation,
the insurer will be required to assess
the suitability of that product for the
relevant potential policyholder. Thisentails an assessment of the policyholder’sinvestment objectives, financial position,knowledge, experience and risk tolerance.
Suitability is a concept resulting fromMIFID II (Section 25(2) MIFID II (Directive
2014/65/EU)). It is important to note that
insurance companies fall, in principle,
outside the scope of MIFID II (Section
2 MIFID II). However, the Insurance
Distribution Directive (IDD) directly
requires insurance companies to offer
suitable products (Section 30(1) IDD(Directive 2016/97/EU). Section 25(2) of
MIFID II and Section 30(1) IDD are both
implemented by Section 4:23 DFSA.55 Thissection mentions ‘financial undertakings’,
which includes insurance companies(Section 1:1 DFSA).
2.4.24 The European Commission noted in
the Action Plan: Financing Sustainable
Growth56 that beneficiaries’ preferences
as regards sustainability are often not
sufficiently considered when advice isgiven by insurers. As part of the suitability
assessment, insurers should ask about
their clients’ ESG preferences and takethem into account when assessing
the range of insurance products to berecommended. Therefore, the Commission
has adopted and amended MiFID II
and IDD delegated acts (Delegated Act
2017/565 (MIFID II)57 and Delegated Act
2017/2359 (IDD)58) on 21 April 2021, toensure that sustainability preferences
are taken into account in the suitability
assessment. The amendments to the MiFID
II and IDD delegated acts are expected
to apply as of October 2022. ESMA
considers it would be a good practice384

for firms to consider non-financial
elements when gathering informationon the client’s investment objectives,and collect information on the client’s
preferences on environmental, social andgovernance factors.59 In a consultation
paper on integrating sustainability risks
and factors in MiFID II ESMA adds that
‘ESG preferences should only be addressed
once the suitability has been assessed inaccordance with the criteria of knowledge
and experience, financial situation andinvestment objectives. Once the rangeof suitable products has been identified
following this assessment, in a second step
the product that fulfils best the client’s
ESG preferences should be chosen.’60 In
this light, it seems to be the case that ESG
preferences can and should fall within
the scope of the suitability assessment,but only on a secondary basis. In ESMA’s
final report on integrating sustainability
risks and factors in MiFID II, ESMA statedthat the consultation paper also included
suggested amendments to guidelines oncertain aspects of the MiFID II suitability
requirements. ESMA intends to finalise
the updates to these guidelines only after
the updated MIFID II delegated acts havebeen fully approved.61
2.4.25 Pursuant to article 4:24a sub paragraph 1of the DFSA any financial service provider,including an insurance company, also hasa general duty of care vis-à-vis prospective
clients and beneficiaries. This general dutyof care requires that the insurer must
carefully consider the justified interestof the prospective client or beneficiary.
This general duty of care for instanceextends to how the insurer charges costs
to the insured or beneficiaries and how
investments are made.

2.4.26 An infringement of a regulatory breachmay result in the AFM taking action
against the insurer.
2.4.27 In addition to the general duty of carepromogulated pursuant to the DFSA,
insurers are also subject to duties of careon the basis of the contract between theinsurer and the insured. These contractual
duties may be invoked by the insured
against the insurance company.
2.4.28 However, in addition to basing a claim
on a breach of contract, an insured or
beneficiary may also attempt to base its
claim on tort, relying on the argumentthat the insurance company infringed its
duties pursuant to the DFSA. This because
an infringement of a statutory duty – inthis case the duty of care created under
the DFSA – qualifies as a tort, permitting aclaim for damages by the insured.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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General insurance / life insurance: legal requirements
to use investment powers to pursue IFSI
2.4.29 As with pension funds and mutual funds,
certain sorts of investment activity are
obviously prohibited in the Netherlands,
such as investment that would facilitate
money laundering. Using investment
powers in accordance with this legislation
can be regarded as a form of IFSI and ourcomments at paragraph 2.2.21 above apply
equally here.
2.4.30 Looking more specifically at the investmentof an insurer’s assets, there are no explicit
legal requirements requiring IFSI (except
where the terms of a policy written by the
insurer require it). However, some insurers
may have shareholders with a medium- or
longer-term interest in the performanceof the insurer who are therefore likely
to be exposed if declining social andenvironmental sustainability damage
that performance. In addition, as noted atparagraph 2.3.6, the directors of an insurer
established as a company have a legal duty
to seek its success, not just for its present
owners, but also for its future owners. As
further noted at paragraph 2.4.15, the needto operate a business to secure its longterm success for its investors and wider
stakeholders, taking account of the impact
of environmental and social sustainability
among other things, is reflected in theCode. In view of this, [the directors of]
insurers should consider what, if anything,
they are able to do to reduce the risk to thecompany’s long-term performance fromdeclining environmental and economic
sustainability. While the [directors] ofeach insurer would need to consider thesituation of that insurer specifically, we
anticipate that in many cases this is likely
to lead them to conclude that the insurer
385

should use its powers of investment anddivestment to pursue positive sustainability
impacts where doing so can reasonably be
expected to help in achieving that goal. As
mentioned already, for listed insurers thisfollows from the Code.
2.4.31 The prudent person rule is a measure thatapplies to setting an investment policyor making investment decisions for the
benefit of beneficiaries (ie in this case theinsured or policyholders), with a view tosafeguarding their future entitlements,
and therefore is a different rule than the
directors’ duty to act in the company’s
interest and to further its continuity.
However, ultimately both rules may
in practice require the same or similaractions from the perspective of IFSI whenit comes to investment decisions.
2.4.32 As explained in the main body of thereport, taking ESG factors into accountdoes not necessarily amount to IFSI (since
it may involve no more than seeking to
avoid short-term financial damage from
ESG risks without pursuing specified
sustainability impact objectives). Similar
factors to those mentioned above would
be relevant for the directors to consider
in determining whether they should
pursue IFSI rather than simply taking
ESG factors into account. Since, bydefinition, individual insurers are notgenerally able to bring about change ata system-wide level, one way of doing
this would be through various forms ofinvestor alliance. Examples of this in
the Dutch context are the SIC and IRBC
Agreement. The Sustainable Investing
Code (Code Duurzaam Beleggen or SIC),62
was established in 2012, for insurance
undertakings in the Netherlands. The
SIC was thoroughly updated in 2018

via the IRBC (International Responsible
Business Conduct) for the insurance
sector (the IRBC Agreement).63 The
idea behind the agreement being thatthe parties are jointly looking forpossibilities to make the improvements
in respect of ESG themes. Examples ofthese themes are: human and labour
rights, including freedom of association,collective bargaining, living wage,
children’s rights, gender, equality andland rights, and climate change, nature,
corruption, health (including access to
medicines) and animal welfare. Examplesof sectors susceptible to ESG violation are:manufacturing industry, energy, mineral
extraction, agriculture, food and fishing,and controversial weapons and the tradein controversial weapons. Within thecontext of the agreement, the parties will
endeavour to cooperate on the basis of‘knowing and showing’, as they recognise
the added value of this approach. The
aim of this joint approach is to achieve
structural change.
2.4.33 The IRBC Agreement provides the Dutch
insurance sector with the opportunity tojoin forces with the government, tradeunions and CSOs to address specificcomplex problems in a structured andsolution-oriented manner. When engaging
in activities of this sort, the [directors]of the company would need to set anappropriate balance between the interestsof investors with medium- and longerterm interests, and those with shorterterm interests.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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2.4.34 In seeking to pursue IFSI, the insurer would
need to ensure that its investment approach
was not inconsistent with the terms of any
policies it has written (which, in the case ofexisting policies, could impose constraints
similar to those discussed above in relation
to mutual funds).
2.4.35 The insurer would also need tocomply with Dutch regulatory capitalrequirements for insurers.

General insurance/life insurance: legal freedom to use
investment powers to pursue IFSIACKNOWLEDGEMENTS

2.4.36 Since insurers own their assets as principal,
there is also flexibility for an insurer topursue IFSI more broadly, if the directors
conclude that doing so is consistent with
discharging their duties to the company.
They might do this, for example, in thelight of growing evidence that investors
wish their investment to ‘do good’ as wellas earning a good investment return.

EXECUTIVE SUMMARY

2.4.37 The expectations set by the Code would
be consistent with the use of a listed
insurer’s investment powers to pursue
IFSI, in particular, where doing so could
be expected to protect the value of thecompany in the long-term.64
2.4.38 As discussed above in the context of duties
to pursue IFSI, the insurer would need toensure that any course of action it adopts
does not breach Dutch capital rules for
insurers or the terms of any policies theinsurer has written.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

386

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3.

ASSET OWNERS’ USE OF THEIR POSITION TO ENGAGE IN STEWARDSHIP ACTIVITIES TO SECURESUSTAINABILITY IMPACT

3.1

The following section considers the extent
to which, and on what basis, each typeof asset owner is (a) legally required or(b) legally permitted or able to use its
position to influence enterprises in which
it invests by engaging in stewardship
activities designed to achieve positive
sustainability impacts and minimise
negative sustainability impacts. In
practice, initiatives have been developed
among asset owners in relation to
engaging in stewardship activities,
although in the main these are all soft
law initiatives, including for instance theDutch Stewardship Code which is further
discussed below.

3.2

sustainability impact sought is intended toaddress system-wide risks from declining
environmental or social sustainability andthe fund has beneficiaries with financial
interests in the medium- to long-term; as
noted, since steps taken by an individual
pension fund on its own are unlikely to beable to address system-wide risks, one of
the most important means of advancing
sustainability impact goals in thesecircumstances is through cooperation
with other asset owners.
Legal freedom to invest for sustainability impact ,3.2.3

Pension funds

Legal requirements to engage for sustainability
impact
3.2.1

3.2.2

387

In the Netherlands, there are no laws that
expressly require pension funds to engage
in stewardship activities, whether designed
to achieve positive or reduce negative
sustainability impact or otherwise.
However, as a general principle, Dutch
pension funds are required to determine
their investment policy in accordancewith the prudent person rule (see Section
2 above). This is not limited to questionsof asset allocation or the use of powers
to invest and divest. It also includes theway in which pension funds engage withthe enterprises in which they invest – ietheir stewardship activities. As discussed
in Section 2, a pension fund would
be required to pursue a sustainability
impact goal where that is in line with theprudent person rule. As also discussed in
Section 2, this may be the case where theAs also noted in Section 2, the prudent
person rule is an ‘open standard’. Theinterpretation and application of theprudent person rule by a pension fund isin principle a matter for the pension fund,and not for, for example, the regulator(although compliance would ultimately
be a matter for the courts). This freedom
permits pension funds considerable
room in pursuing positive sustainability
impact, including engaging in stewardship
activities, even where the ultimate goal
is not to address system-wide risks, as
described above. The prudent person
rule is certainly more permissive thanthat as regards stewardship activities
and would also permit ultimate-ends
IFSI, in particular where this would notadversely affect the rights of beneficiaries.
For instance, where there would be only
limited costs involved with doing so.

Observations on stewardship activity by Dutch
pension funds
3.2.4

As mentioned above, the vast majorityof Dutch pension funds have developed
an ESG investment policy which covers

stewardship activities as well as the use of
powers of investment and divestment.
3.2.5

3.2.6

3.2.7

Both ABP and PMT have included in theirrespective stewardship policies that theyshall actively use their voting and meeting(/discussion) rights to engage in IFSI. Bothstate that they will enter into conversation
with companies in which they invest, toinfluence the companies’ strategy andimpact on the policy and behaviour ofsuch companies.65
ABP had listed some achievements in its
2019 sustainable investing report thatshow how ABP as part of its stewardship
activities has used its shareholder rights.66
On these items, ABP has cooperated withother pension funds, investors and NGOs.
Since ABP wants the companies it invests
in to be socially responsible and take into
account, among other things, humanrights, this cooperation between investors
and other stakeholders has for instanceresulted in conversations with multiple
raw materials companies which have led
to human rights being better taken into
account and monitored. Furthermore,
multiple technology companies, suchas Facebook and Alphabet (Google) havebeen confronted by ABP on issues such asprotection of data and privacy.
Also, since 2015, ABP has entered into
conversations with 10 large companies
in the clothing industry, where themain issue is the human rights/labour
conditions (at these companies or with
suppliers to these companies) and which
also addresses the monitoring andtransparency around suppliers and thesustainability of the goods produced.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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3.2.8

3.2.9

PMT has set itself some guidance inthis regard in its ‘responsible investing
policy’, ie to enter into conversations withcompanies that are guilty of (severe formsof) bribery, corruption, market abuse andbreach of laws regarding human rights andthe environment.67 Also from PMT’s 2019
annual report it appears that it has actively
used its power as (large) shareholder, toencourage companies to think about ESG
topics that raise risks for the environmentand society: in these conversations they
aim to stress the importance of proper
governance, the climate and social factors.
It is stated in PMTs annual report that incase such conversations do not lead tothe envisaged results, PMT may consider
terminating the investment.68
As mentioned above, pension funds do
not only engage in stewardship activities
on an individual basis. There are also
examples of pension funds joining witheach other, other investors and nongovernmental organisations (NGOs) to
be more effective in seeking to achievesustainability impacts. An example is theagreement “Maatschappelijk Verantwoord
Beleggen Pensioenfondsen” which has beensigned by over 80 Dutch pension funds
as well as by the Dutch government,
six civil society organisations/NGO andtrade unions.69 Under this agreement,
the parties aim to prevent or tackle
negative consequences for society and theenvironment of investments by pension
funds. The parties contribute theirknowledge and expertise to this end. The
agreement was arrived at with guidancefrom the Social and Economic Council of
the Netherlands (SER).

3.2.10 With this agreement, the pension funds
are joining forces with the other parties to388exert influence worldwide and to preventor tackle problems in the chains of theseenterprises in the areas of human rights
and the environment.
3.2.11 The pension funds that are signatories
have chosen an approach based on theOECD Guidelines for Multinational
Enterprises and the UN Guiding Principles
on Business and Human Rights (UNGPs) to
identify, prioritise and address such ESG
risks. In this agreement, ESG risks refer torisks for society and the environment.
3.2.12 At this time most pension funds have ageneric code of conduct or stewardshippolicy, which refers more generally tothe fiduciary duties of directors without
containing language indicating that
directors specifically have the duty to
pursue IFSI. This appears in line withthe conclusion that the Association of
Investors for Sustainable Development(Vereniging van Beleggers voor Duurzame
Ontwikkeling or VBDO) has drawn in its
annual investigation into the status ofsustainability at the largest 50 Dutch
pension funds. ABP was ranked first,
while PMT was ranked fifth on the 2020
ranking, published late October 2020.70
3.2.13 VBDO states that most pension funds areadvised by responsible investment experts,
also noting that the level of knowledge on
the topic within board rooms is still notwhat is should be. VBDO has found, througha specified director’s questionnaire, that 55
per cent of the board members of pension
funds do not have available knowledge on
responsible investment, and that an ESG
course or training has only been completed
by 16 per cent of the board members ofpension funds.
3.2.14 The Dutch Stewardship Code, publishedby Eumedion in 2018,71 provides 11 non-binding principles for stewardship by asset
owners and investment managers towards
Dutch listed investee companies. These
require asset owners to consider ESG factors
as part of their stewardship engagementwith listed investee companies, thereby
protecting future financial return fromdeclining sustainability and in order toachieve positive sustainability impact as an
end in itself.
3.2.15 Eumedion is a Dutch organisationthat represents the interests of Dutch
institutional investors in the fields ofcorporate governance and sustainability.
Pension funds, insurers, investment
institutions and asset managers affiliatedwith Eumedion are expected to apply the‘comply or explain’ principle with regard
to the Dutch Stewardship Code and reporton its implementation. The code is soft
law and does not have a formal legal basis,
although in practice is does provide animportant framework for engagement by
Dutch investors, such as pension funds orinvestment managers.72
3.2.16 The Dutch Stewardship Code sets outthat a stewardship policy should, among
other things, promote long-term value
creation (Principle 1). Monitoring investee
companies on among others social andenvironmental impact is also one of theprinciples under the Dutch Stewardship
Code. The Code sets out a number ofbest practices in this area and provides
guidance for investor engagement that
goes beyond the rules existing as amatter of Dutch ‘hard’ law. The Codeprovides that asset owners and investment
managers should exercise their voting
rights in an informed manner, and thatthey should disclose voting at individualcompany level on a quarterly basis.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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General voting behaviour should be
disclosed annually (Principle 7).
3.2.17 While the Stewardship Code does not
expressly address pursuing sustainability
impact as a goal in its own right,
Eumedion has expressed the view thatsince asset owners and investment
managers hold the bulk of shares in
Dutch listed companies and manageother people’s and institutions’ money,society at large expects both Dutch andnon-Dutch asset owners and investment
managers to take responsibility in playing
an active role in promoting good corporate
governance and sustainability practices in(large) public companies.
3.2.18 What pension funds can and should
do in practice needs to be understoodby reference to their legal powers andduties, summarised in Section 2, rather
than social expectations. However, as
noted, the prudent person rule sets an‘open’ standard and prevailing social
expectations may nonetheless have an
influence on how the directors of the fundview their duties and consequently what
the prudent person rule entails.
3.3

Mutual funds

Legal requirements to engage forsustainability impact
3.3.1

3.3.2

389

In the Netherlands, there are no specificlegal requirements for UCITS managers(acting as or on behalf of the relevant UCITS
fund) to engage in stewardship activities.
The Dutch Stewardship Code, discussed atparagraph [3.2.14] above, applies to UCITS
managers as they fall within the scope of
application of the code. They are therefore
expected to apply the ‘comply or explain’
principle when complying with the Codeand report on its implementation. Even

though the Dutch Stewardship Code is notlegally binding and does not therefore,
on its own, result in a requirement toengage for sustainability impact, asa best practice guide it does promotestewardship, including with a view tosustainability impact and not only with aview to financial performance. For UCITS
the room for IFSI is further determined by
the funds documentation as further set
out below.

market or sector; where it is clear thatthe relevant market or sector is facing
sustainability risks that are likely to havea material adverse effect on the value ofthe fund in the long-term, there may besome justification for the fund seeking
to engage with companies in which it
invests in order to seek to minimise thedamage on the basis that this is in thebest interests of investors. Because of
the challenges and cost of engagement
activity of this sort, unless the fund were
unusually large, it would probably need to
do this in association with other investors(not least because of the extremely
low management charges for passive
investment funds.) A further exception
might be where the fund accesses theinvestment management services of aninvestment manager principally to benefit
from the investment manager’s expertiseas an investor, but where the investment
manager operates a stewardship approachacross all or most of the portfolios
it manages that involves it pursuingsustainability impact goals. However,in this case, the appointment of theinvestment manager would be motivatedby the desire to access its investment
services, with its engagement activities
being incidental to that.

Legal freedom to engage for sustainability impact
3.3.3

3.3.4

As discussed in Section 2, the Dutch
regulations for UCITS are designed toprovide a high level of investor protection.
Where a UCITS does not have an express
sustainability impact investment
objective, or at least where engaging forsustainability impact is not contemplated
in the investment policy of the UCITS,
we consider that the scope, if any, forengaging in stewardship activities withthe goal of achieving a sustainability
impact is likely to be limited.
In theory, since stewardship activities do
not principally concern the compositionof a fund’s portfolio, it might be possible
to engage in stewardship activities withthe goal of achieving a sustainability
impact even where the fund’s investment
objective and investment policy are silent
on the point. However, since doing sowould involve a cost, it is questionable
whether that cost could be met out of
the assets of the UCITS fund since thecost would not have been incurred infurtherance of the fund’s investment
objective or in accordance with its policy.
A possible exception might be where
the fund passively tracks a particularinvestment market or sector, so that it andits investors will always be exposed to that

3.4

Insurance undertakings

Legal requirements to engage forsustainability impact
3.4.1

3.4.2

The law does not expressly require life or
non-life insurers to engage in stewardship
activities aimed at achieving positive or
reducing negative sustainability impact.
However, as noted73 as a general principle
under Dutch corporate law, when
performing their duties the directors of
an insurance company must act in the

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

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United Kingdom
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company’s interest, which in broad terms
is defined as the synthesis of the interestof the company in its own continuity
and prosperity, accounting for all of theinterests of its stakeholders. Also listed
life and non-life insurers would need toapply the Corporate Governance Code.
Similarly, the Dutch Stewardship Codealso applies to these insurers. For thereasons as set out in Section 2, in manycases the directors of insurance companies
are likely to conclude that they should
pursue instrumental IFSI where doing
so can reasonably be expected to help inachieving the goal of reducing the risk
to the company’s long-term performancefrom declining environmental andeconomic sustainability.
3.4.3

390

Any decision to pursue sustainability
impact would need to take account of theterms of any policies that the insurer has
written. In particular, where a life insurer
wishes to cover the cost of engagement
activity out of funds held and managed by
the company in connection with policies
that are essentially investment products,
doing so would need to be consistent withthe terms of the relevant policies andthe regulatory requirement to act in thebest interests of policyholders, including
the prudent person rule as it applies toinsurers pursuant to the DFSA.74 If thepolicy terms do not expressly contemplatesome form of ‘sustainable investing’ thismay prove a constraint. However, eachsituation would need to be consideredon its own facts. For example, it may bethat the cost of maintaining different
stewardship approaches for different
books of business makes it unfeasible,
so that it would be reasonable for an
insurer to adopt a firm-wide approachto stewardship as the cheapest option

for all policyholders, which includes
engagement activity designed to achieve
positive sustainability impact. Further,
the larger the portfolios of the insurancecompany, the lower the ‘unit cost’ forany policyholder of engagement activity,
including any additional cost resulting
from engagement on sustainability issues.
3.4.4

3.4.5

The Dutch Corporate Governance Codeand the Dutch Stewardship Code (seeparagraph 3.2.14) taken together with
the IRBC Covenant (see paragraphs[XX]),
support the notion that the duties of
directors of Dutch insurance companies
may lead them to conclude that theircompany should engage in stewardship
activity with the aim of achieving
sustainability impacts so as to protect
their business from long-term risk fromdeclining social and environmental
sustainability. They may also leaddirectors of insurance companies toconclude they should cooperate with otherinsurers when engaging in stewardship
activity. Insurance companies should
apply the ‘comply or explain’ principle
in line with the codes and report on theirimplementation. As set out previously,both the Dutch Corporate Governance
Code and the Dutch Stewardship Code are
non-binding.
The IRBC Agreement (see para 2.4.32)
requires insurance undertakings to invest
in a responsible manner, whereas thegoal of the parties that are signature
to the agreement is to effect structuraland systemic change regarding positive
sustainable impact as part of theirinvestments.

3.4.6

The IRBC Agreement does not specificallyaddress directors, but looks at insurance
undertakings as a whole. Through thecovenant the insurers agree to cooperate
in and, where necessary, hold eachother accountable for, compliance withand abiding by the (goals set out in the)covenant. Performing ESG due diligenceis listed as one of the priority items under
the covenant: insurance undertakings are
expected to perform ESG due diligence on
an ongoing basis, where not just the mainrisks for the insurance undertaking itself
are addressed, but also the potential andactual risks of negative ESG impact forother stakeholders as well.75

General insurance: Legal freedom to engage forsustainability impact
3.4.7

3.4.8

For the reasons set out in Section 2, sinceinsurers own their assets as principal, thereis flexibility for an insurer to pursue IFSI,
provided that the directors conclude thatdoing so is consistent with discharging
their duties to the company. The same
analysis will apply to engaging with a view
to pursuing sustainability impacts.
When pursuing an objective forsustainability impact in their engagement
as shareholders, insurance companies
would also need to abide by the termsof the relevant insurance policy as wellas the applicable legal framework underfinancial regulatory law, including theprudent person principle. Please seeparagraph [2.2.60]

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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Life insurance: Legal freedom to engage forsustainability impact

ACKNOWLEDGEMENTS

3.4.9

EXECUTIVE SUMMARY

It is worth noting that for life-insurers thelegal freedom may be limited pursuant to
the type of life insurance.

3.4.10 Dependent on whether the life insuranceis ‘with profits’ or ‘unit-linked’, as further
explained in paragraphs [2.1.57 and 2.1.58]
the investment risk lies with the insurancecompany or the relevant insurance
policyholder.76 For unit-linked life policies,
the relevant policyholder selects thefunds they wish to invest in from a range
available. Where the relevant policyholder
does not have a say in the funds in which
the life insurer will invest their premium,the life insurer has less freedom to pursue
IFSI than is the case where the policyholder
does have a say.
3.4.11 Also, life insurers may be prevented fromsetting a particular sustainability impact
objective, for instance where the insurer
has received opposition from relevant
policyholders against the view on which
the sustainability impact objective is basedor where setting the objective is projected
to result in significant financial detriment
to the fund.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

391

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4.

ASSET OWNERS’ ENGAGEMENT IN PUBLIC POLICY WORK TO SECURE SUSTAINABILITY IMPACT

4.1

The following section considers the extent
to which, and on what basis, each type of
asset owner is (a) legally required or (b)legally permitted or able to use its position
to engage in public policy work designed
to achieve positive sustainability impact
and minimise negative sustainability
impact, for example, where this is relevantto the value of portfolio assets.

4.2

By way of general introduction, Dutch law
does not expressly require asset owners
to engage in policy discussions and/or tolobby policymakers to achieve positive
and/or reduce negative sustainability
impacts. However, the duties of asset
owners (especially those of trustees/
directors of pension funds and directors of
insurers), may nonetheless lead them toconclude that they are required to engage
in these activities in similar circumstances
to stewardship activity, considered above.

Pension funds
4.3

In the Netherlands, the prudent personrole grants a pension fund discretion todetermine its investment policy, including
the extent to which ESG and sustainability
factors are part of that policy and how
these factors are consequently taken into
consideration. Within such framework, apension fund (or an investment manager
acting on its behalf) can certainly engage
in policy discussions and/or lobbying,and in practice this also what happens tovarying degrees.

Mutual funds
4.4

Pursuant to the DFSA, engaging in policy
discussions and/or lobbying by UCITS
managers is not expressly prohibited andwould be subject to the general framework/
restrictions as set out in Section 2 above,
including that such engagement should notcause the UCITS manager to act in breachof its duty of care vis-à-vis the UCITS and its
unit-holders.

Insurance undertakings
4.5

Pursuant to the DFSA, engaging in policy
discussions and/or lobbying by insurance
undertakings is not expressly subject tothe (legal) framework / restrictions inrelation to insurers’ beneficiaries andstakeholders (as applicable), as set out inthe paragraphs above.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

392

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5.

ESTABLISHING NEW FUNDS TO INVEST FOR SUSTAINABILITY IMPACT AND AMENDING THE
TERMS OF EXISTING ONES

5.1

The following section considers the extent
to which it is possible for an asset owner to
set up a fund, policy or other product withthe express objective of pursuing IFSI.

5.1.1

Essentially, the ability to establish new
funds or sub-funds that pursue IFSI isgreatest with mutual funds and insurance
policies since, with these products, there ismore flexibility for investors to accept therisk of a reduced level of financial returnin return for sustainability impact. In allcases, investor protection rules would need
to be carefully considered and compliedwith. The operating rules for UCITS in
particular could impose constraints on thesort of sustainability impact strategy thatcan be pursued; in particular, it would not
be easy to invest in illiquid assets or thosethat are difficult to value. Amending theterms of existing UCITS and life policies
to allow for greater flexibility to pursue
IFSI would generally require some form ofinvestor consent and a need to comply withvarious investor protection requirements,
making this a potentially expensive andtime-consuming option.

Pension funds
5.1.2

5.1.3

393

As the prudent person role requires apension fund to, among other things,
protect and safeguard the ability of thefund to satisfy the future entitlements ofthe beneficiaries, a pension fund would
likely not be able to set up a vehicle thatsolely focuses on sustainability impact
without regard to financial return, unlesspart of a wider and more diversified
investment portfolio.
Essentially, the ability to establish new
funds or sub-funds that pursue investingfor sustainability impact is greatest withmutual funds and insurance policies since,with these products, there is more flexibility
for investors to accept the risk of a reduced
level of financial return in return forsustainability impact. In all cases, investor
protection rules would need to be carefully
considered and complied with. The operating
rules for UCITS in particular could impose
constraints on the sort of sustainability
impact strategy that can be pursued; inparticular, it would not be easy to invest in
illiquid assets or those that are difficult tovalue. Amending the terms of existing UCITS
and life policies to allow for greater flexibility
to pursue IFSI would generally require
some form of investor consent and a needto comply with various investor protection
requirements, making this a potentiallyexpensive and time-consuming option.
5.2

5.2.2

Mutual funds

Establishing a new UCITS/new sub-fund of an
existing UCITS umbrella
5.2.1

The main purpose of a UCITS is to act asa collective investment vehicle with theaim of enabling a financial return for its
unit holders.77 Subject to that, UCITS are inprinciple permitted to have non-financial
investment objectives, such as IFSI,
provided investor protection requirements
such as appropriate disclosures are duly
met. An important disclosure aspect is forexample that the prospectus of the UCITS
would need to set out the risks and/or costs
associated with IFSI to allow investors
to make an informed judgement of the
proposed investment and the risks attachedthereto, which in practice may not beeasily quantifiable.78

Those wishing to set up a sustainability
impact UCITS would therefore need tocarefully consider its design and the way
it is described to investors. Among otherthings, the sustainability impact aims
of a UCITS would need to be reasonably
capable of being successfully carried into
effect, not least because the policy of the
UCITS would otherwise be misleading.
The AFM can refuse to authorise UCITS
that set objectives that are so overly
ambitious that they would mislead
investors. Operational challenges would
also need to be addressed. For example,
under applicable valuation requirements,a UCITS manager must among others beable to demonstrate that participationsin UCITS under its management havebeen accurately valued.79 In practice, itwill likely be challenging to measureand quantify the impact on valuation
resulting from the fund’s sustainability
impact investments. The valuation or
evaluation methods used by sustainability
impact funds, particularly those withbroad sustainability impact objectives
or broad discretionary powers for UCITS
managers to assess sustainability impact,
are therefore likely to come under close
scrutiny from regulators.

Amending an existing UCITS
5.2.3

It would be possible to amend theinvestment objectives or policy of an existing
UCITS. However, it could be costly andtime-consuming, and a UCITS manager
might be cautious about any amendmentthat could materially affect the financial
position of existing investors. Although
the regulatory rules and guidance for
UCITS do not expressly address a change of

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
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REFERENCES

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investment objectives or policy to permit
IFSI, this is in practice likely to amountto a change that would require approvalby the unit holders under the fund rules(fondsreglement) or articles of incorporation(statuten) of the UCITS. Amendments to the
UCITS’ objectives or policy laid down in thefund rules or instrument of incorporation
would also require AFM approval80, as well as
publication of a revised prospectus and KIID.

that as part of its supervisory duties, itwill be expecting financial institutions tointegrate sustainability aspects into (among
others) their product governance and ensuretransparency in that regard.81 ESMA guidancestates that where the product has ‘specificinvestment objectives such as…, “green
investment” [and] “ethical investment”’,
these should be specified as part of the target
market characteristics.82 Under current
EU proposals, UCITS manufacturers would
be required to specify the sustainability
preferences of the target market for all UCITS
and to ensure that the fund’s characteristics
are compatible with those preferences.

Duties on those designing, manufacturing andproviding mutual funds
5.2.4

5.2.5

394

Product governance rules require
manufacturers of UCITS to specify a‘target market’ for the product andensure that the product’s characteristics
are consistent with the target market.
Manufacturers must regularly review
their products for consistency with thetarget market that was specified. If a
UCITS manufacturer determines that the
product is no longer appropriate for its
target market, it would need to revise thetarget market and distribution strategy
and consider informing the existing
investors. The manufacturer would not be
required to amend the characteristics ofthe product.
The current product governancerequirements in relation to specifying
and understanding the needs of a target
market do not as such refer to sustainability
considerations. This focus is reflected
in industry guidance. Nonetheless, it
is increasingly clear that a significant
group of investors have sustainability
concerns which they would like to see
reflected in their investments, as wellas financial goals. Indeed, regulators are
increasingly encouraging the considerationof sustainability characteristics in target
market specifications. The AFM has indicatedLife insurance products
Establishing a new policy
5.2.6

5.2.7

Provided that applicable consumer protection
requirements, including those concerning
product design and marketing requirements,
are satisfied it would be permissible for life
insurers to create products with investment
objectives that seek IFSI.
However, certain factors can make it
difficult for an insurer to set a sustainability
impact objective. For example, restrictions
around the composition of the portfolio (egunder the prudent person rule) could limit
the methods through which a sustainability
impact objective can be implemented, forinstance by limiting opportunities to invest
directly in infrastructure projects, realestate and unlisted companies with strong
ESG credentials because of the illiquid
nature of these type of investments.

Amending an existing policy
5.2.8

Amendments of policy documents toincorporate an express IFSI objective
is possible but would typically requirepolicyholder consent. Obtaining it is likely
to be expensive and time-consuming.

Duties on those designing, manufacturing andproviding life insurance
5.2.9

Similar product governance requirements
to those set out in paragraph 5.2.4 above
apply in relation to investment life
insurance products.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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6.

INVESTMENT MANAGERS’ DUTIES TO INVEST FOR SUSTAINABILITY IMPACT

6.1

This section considers the extent to which,and in what circumstances, an investment
manager is (a) legally required or (b) legallypermitted to pursue IFSI on behalf of anasset owner or otherwise, in each of thethree ways contemplated in Sections 2-4.

6.2

Typically, an investment manager’s
investment duties and powers are shaped by:(a) the terms of its investment managementagreement (IMA) with an asset owner. The
IMA will typically specify:(i)to sustainability impact ; and84(c) any duty of care vis-à-vis asset owners or
third parties on the basis of tort for the
purposes of Article 6:162 of the DCC (seealso Section 7 below).

Powers of investment and divestment
6.3(ii) any investment strategy specified by
the asset owner;(iii) any investment restrictions; and(iv) any contractual standard of care;

395

6.5

Legal obligations with respect tosustainability impact

investment objective(s) against
which the investment manager’s
performance (and performance-related
remuneration) will be assessed;(b) statute and delegated legislation,in particular relevant requirements
stemming from the DFSA, include
observing a general duty of care (zorgplicht)
vis-à-vis clients and the requirement for
an investment manager to ensure thesuitability of an investment mandate (andthe investment decisions thereunder) for
its client, essentially comprising a duty
to ensure that the client understands the
mandate and the risk it entails and isable to bear those risks. Although there
is currently no express requirement tosolicit clients’ objectives with regard to
the sustainability impact as part of thesuitability assessment, it is considered
best practice.83 Future amendments tothe suitability assessment regime may
require that investment managers seek
information on client views with respect

Engagement to achieve sustainability impact

6.4

Where the IMA requires IFSI, theinvestment manager must pursue a
strategy which complies with that.
Investment managers are likely to wantto ensure that the mandate is clear about
the sustainability impact objective being
set and how progress towards it is to beassessed, and specifies how it should bebalanced with the financial objectives ofthe mandate to minimise the investment
manager’s exposure to complaints andpossible litigation.
Where an IMA has expressed all of thematerial terms of the agreement between
the investment manager and the asset owner
and is silent on sustainability impact, we do
not consider that an investment manager
would be under a duty to pursue IFSI, as thelegal relationship between the asset ownerand the investment manager will primarily
be governed by the IMA, and the DFSA does
not supplement it such that absent a specificreference to IFSI, an asset manager may
interpret the agreement in such a mannerthat ultimate-ends IFSI would be permitted.
This is different for instrumental IFSI, whichshall generally fall within the scope of the
IMA, arguably even when not specificallyagreed, unless precluded by reference to a
specific benchmark that would preclude
even instrumental.

6.6

As for powers of investment or divestment,
an investment manager would need tocomply with the IMA. Where the IMA issilent on sustainability impact, the starting
point is that there is unlikely to be any
legal requirement for investment managers
to engage with portfolio companies toachieve sustainability impact.
However, the position of the investment
manager may be somewhat different
in its stewardship activity, as comparedwith its use of powers of investment anddivestment. In particular, it is possible
to foresee circumstances in which
an investment manager takes a firmwide approach to stewardship activity
across all of the portfolios it manages
which involves the investment manager
seeking to achieve sustainability impact(believing this to be in the best interestsof its clients generally). While eachsituation would need to be considered on
its own facts, in circumstances such as
this, where the asset owner’s principal
motivation is to access the investment
manager’s investment expertise and theasset owner has not opted its assets outof the investment manager’s stewardshipprogramme, it would be reasonable toconclude that the investment manager isauthorised to pursue sustainability impact
in this way. The investment manager
would nonetheless need to be satisfied
that its activities would not prejudice
the realisation of the agreed financial
investment objective under the portfolio.

Public policy work to achieve sustainability impact
6.7

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As above, an investment manager’s duties
would follow the terms of its mandate.
Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGNETHERLANDSCONTENTSFOREWORDSINTRODUCTION

Where the mandate is silent as tosustainability impact, we anticipate thatthe position is likely to be broadly similar
to that in relation to stewardship activities.

6.9

Legal freedom to invest for sustainability impact
Powers of investment and divestment
6.8

396

Where the IMA is silent on IFSI, theinvestment manager’s contractual andnon-contractual duties are likely tomake them cautious about setting asustainability impact objective if doing
so could create a risk that the financial
investment objective of the portfolio
would not be achieved. In the event ofunder-performance, the investment
manager’s investment approach islikely to be benchmarked against thatof other managers operating portfolios
with similar risk/return balances. As aresult, an investment manager could
be exposed to litigation risk even where
it takes into account sustainability
impact only as a secondary factor where
the financial return on the portfolio is
weaker than that of other managers
that have not attempted to achieve asustainability impact. Likewise, thesuitability assessment requirement under
the DFSA, mentioned above, will limit
the scope for taking sustainability impact
factors into account in its investment
policy where the client has not identified
this as one of its objectives. Finally, in theabsence of contractual clarity as to theclient’s wishes, there is some risk that it
could result in the investment manager
breaching its duty not to allow conflicts ofinterest between itself and its client.

If the asset owner wishes to incorporate
IFSI, the IMA should be amended
accordingly; non-contractual discussions
would remain subordinate to the terms of
the IMA. The investment manager and asset
owner could agree to amend the terms ofan existing IMA so that it contemplates IFSI.
However, an asset owner’s ability to do thisis limited by its own investment duties (seeSections 2-4 above).

6.11

Public policy work to achieve sustainability impact
6.12

Engagement to achieve sustainability impact
6.10

Since stewardship activities are less likely
to affect the composition of an investment
portfolio (and hence the achievementof the financial investment objective of
the portfolio), there may be more scope
to pursue sustainability impact throughstewardship activities, even where the IMA
is silent upon the point (and the investment
manager does not operate a firm-wide
engagement policy that contemplates
stewardship with a view to achieving
sustainability impact, as discussed atparagraph 6.5 et seq above). However, theinvestment manager would need to be able
to establish that doing so is in its client’s
best interests and is unlikely to prejudice
the realisation of the financial investment
objective of the portfolio. Because of the
duty of care an investment manager owes
to each of its clients, it would also need tobe satisfied that pursuing sustainability
impact through its stewardship activity will
not bring its obligations to one client into
conflict with the duties it owes to otherclients (without appropriate disclosures andwaivers being in place).

In the absence of any provision in the
IMA, an investment manager is unlikely
to feel confident about engaging forsustainability impact where doing so is
likely to cost the portfolio more than it
can return.

6.13

An investment manager is broadly free
to engage in public policy work on its
own behalf and funded from its own
resources, provided that doing so does
not create a conflict of interest between
the investment manager and its clients(or between the duties owed to various
clients, to the extent any such work isundertaken on any of their behalf).
Where an investment manager isundertaking public policy work on behalfof a client, its position is likely to bebroadly similar to that for stewardship
activities, discussed above.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

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FranceJapan

Netherlands

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REFERENCES

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7.

LEGAL LIABILITY TO THIRD PARTIES FOR THE NEGATIVE SUSTAINABILITY IMPACT OF
ENTERPRISES IN WHICH PORTFOLIOS ARE INVESTED

7.1

This section considers, regardless of thelegal rules under which it is required tooperate and its constitution, the extent
to which an asset owner could be legally
liable to third parties for the negative
sustainability impact of enterprises
in which it invests, and whether aninvestment manager could also be
liable because of its role in assisting theasset owner to invest in the relevant
enterprise and steward its investment.
In what follows, we have considered theposition where an asset owner invests
as a shareholder in a Dutch limited
company. Most business enterprise in the
Netherlands is conducted through limited
companies. However, the position could
vary where the vehicle concerned is nota limited company or where investment
is not by way of shares. An investor’s risk
where it invests in business enterprises
conducted through non-Dutch vehicles
would depend upon the legal natureof those vehicles in the jurisdictions inwhich they are established and is beyond
the scope of this report.

7.2

Essentially, two issues need to be considered.

7.3

First, to what extent are businessenterprises in which asset owners invest
likely to find themselves subject to legal
liability for their negative sustainability
impacts; and second, even if the enterprise
is liable, how likely is it that an asset
owner or its investment manager would
be held liable as well?

to court by interest groups wishing toadvance issues of broad public concern,such as human rights,85 environmental
issues,86 and climate change.87 In a
couple of these cases, Dutch courts haverendered landmark rulings due to which
the litigation risk regarding negative
sustainability impact against businessenterprises in general has increased.
7.5

7.6

Liability risk of business enterprises for their
negative sustainability impact
7.4

397

Recently both the Dutch State as wellas business enterprises have been taken

7.7

Notably, the Hague District Court on
26 May 2021, in a case brought by theenvironmental group Milieudefensie/
Friends of the Earth Netherlands and coplaintiffs, including several NGOs that theparent company of the Shell group, RoyalDutch Shell, established in the Netherlands(RDS), found that on the basis of applicable(international) soft law frameworks88,
RDS has an obligation to reduce the CO2
emissions of the Shell group’s activities(the Milieudefensie/RDS ruling).89 Subject toappeals, this is a ground-breaking decision
as for the first time, a court has found thata private company owes a duty of care to
reduce its CO2 emissions.
The Milieudefensie/RDS case builds
on the landmark Urgenda decision in
December 2019.90 In the Urgenda case,
the Dutch Supreme Court consideredthat human rights offer protection
against the consequences of dangerous
climate change caused by CO2 emissions
and found that the Dutch government’s
policies to reduce greenhouse gas
emissions were insufficiently stringent
and the Dutch state violated a similar dutyof care to its citizens.
In the Urgenda case the state was held
liable on the grounds of its duty ofcare under Article 6:162 DCC towards
its citizens by failing to take sufficientmeasures to avert the imminent danger
caused by climate change.
7.8

It follows from the judgment that
instruments of soft law (consideredfrom a national legal perspective within
the Netherlands), including the Paris
Agreement, while legally not binding
between parties nationally, may influence
the court in determining the content ofa duty of care. The court also referred
to articles 2 and 8 of the European
Convention for the Protection of Human
Rights and Fundamental Freedoms (ECHR)
as important factors in determining thescope and extent of the state’s duty of care
under Article 6:162 DCC:
‘43. In short, the State has a positive obligation
under Article 2 ECHR to protect the lives ofcitizens within its jurisdiction, while Article
8 ECHR creates an obligation to protect theright to home and private life. This obligation
applies to all activities, public and non-public,
which could endanger the rights protectedin these articles, and certainly in the case ofindustrial activities which by their nature are
dangerous. If the government is aware that there
is a real and imminent threat, the State musttake precautionary measures to prevent the
infringement as far as possible. In the light of
this, the court shall assess the alleged (imminent)
climate dangers.
(…)
69. The State also relied on the trias politica andon the role of the courts in our constitution. The
State believes that the role of the court stands
in the way of imposing an order on the State, as
was done by the district court. This defence does
not hold water. The Court is obliged to apply

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
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provisions with direct effect of treaties to which
the Netherlands is party, including Articles 2 and
8 ECHR. After all, such provisions form part of
the Dutch jurisdiction and even take precedence
over Dutch laws that deviate from them.’
7.8.1

7.8.2

7.8.3

398

Up until recently, it was expected that
imposing human rights duties in a similar
way on private enterprises would prove
to be substantially more difficult as
obligations arising from human rights
treaties (or the Constitution) do not in
principle apply directly to companies
under Dutch law. This expectation now
seems to have been outdated by the
Milieudefensie/RDS ruling.
The Milieudefensie/RDS case is a civil caseagainst a business enterprise in whichplaintiffs had requested the Dutch court
order Shell to limit the joint volume of all
CO2-emissions associated with its businessactivities and fossil fuel products to zeroby 2050, based on Shell’s duty of care
under Article 6:162 DCC. Miliedefensie
bases this duty of care inter alia on soft law
frameworks and made references to theUrgenda case in this context.
In the Milieudefensie/RDS case, the court,
considered that, based on inter alia theParis Agreement’s goals and the scientificevidence regarding the dangers of climatechange, RDS has a duty of care to takeaction to reduce its greenhouse gas
emissions.91 This duty of care is based on
Article 162 of Book 6 DCC which provides
that an act or omission breaching a
duty imposed by a rule of unwritten law
pertaining to proper social conduct results
in a tort. While the court acknowledgedthat human rights and other soft law
instruments cannot be directly invokedby plaintiffs because they only apply in
relationships between states and citizens,the court does factor these into its
interpretation of the relevant unwritten
duty of care in the DCC.
7.8.4

7.8.5

Another important element for the court
in interpreting the unwritten duty of careis RDS’s role as the top holding companyof the Shell group. RDS establishes theoverall Shell policy, including the climate
policy, and is in fact responsible forhaving an ‘oversight of the climate risk
management’ and for reporting on thegreenhouse gas emissions of the various
Shell companies, who are only responsiblefor implementation and execution
Applying the unwritten duty of care, thecourt found that RDS has an obligation
to reduce the CO2 emissions of the Shellgroup’s activities by net 45 per cent by
the end of 2030 compared to 2019 levels
through the Shell group’s corporate
policy. This so-called ‘reduction obligation’applies to the Shell group’s entire energy
portfolio and to the aggregate volume ofall emissions (Scope 1 through to Scope392). The court, however, did distinguishbetween scope 1, 2 and 3 emissions. The
court expresses the reduction obligation asan ‘obligation of result’ for the activitiesof the Shell group (Scope 1 emissions)and a ‘significant best-efforts obligation’with respect to the activities of parties
outside of the Shell group, including
suppliers (Scope 2 emissions) and endusers (Scope 3 emissions). The court did
not seek to prescribe how RDS shouldmeet the 45 per cent reduction obligation,
instead leaving it up to RDS to design the
reduction. Nor did the court indicate how
the order will be enforced or monitored;
the decision is, however, expressed to beprovisionally enforceable meaning it will
not be automatically suspended pending

an appeal. The decision does not render
RDS’s current activities unlawful: instead,it sets a target to be achieved by 2030 andallows RDS to decide on the pathway to be
adopted to achieve this.
7.8.6

7.8.7

7.8.8

The Milieudefensie/RDS ruling is expected
to be followed by more strategic climatechange litigation initiated by NGO’s and/or individuals with the aim of seeking to
influence corporate behaviour and holdbusiness enterprises liable.
We note that also prior to theMilieudefensie/RDS case, the Dutch courts
have repeatedly used soft law frameworks
to assess the nature and scope of the
duty of care of enterprises and financial
institutions. Indeed, in one case not
involving negative sustainability impact,
the Supreme Court ruled that even though
the case concerned a non-binding code of
conduct (and thus not a binding rule ofDutch law) the relevant provisions could
be a relevant factor in assessing the natureand extent of the bank’s duty of care vis-àvis its customer.93
Another example of a recent casein which soft law plays a role are
the summary proceedings between
Greenpeace and the Dutch state. In
December 2020, the interim relief judge
dismissed Greenpeace’s claim that thestate had to attach stricter climaterelated conditions to the state aid granted
to Dutch airline KLM. Greenpeaceargued that this duty is imposed on thestate under the UN climate treaties, the
ECHR and the judgment of the Supreme
Court in the Urgenda case. 94 The court
dismissed Greenpeace’s claims interalia because the emission reductions
called for by Greenpeace go beyond theobjectives agreed at international level.

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B. THE EXTENT TO WHICH
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Nor can such duty be inferred fromthe Urgenda case, because according to
the court, the state’s conviction in that
judgment relates only to greenhouse gas
emissions in the Netherlands.
7.8.9

Furthermore, on 29 January 2021, theHague Court of Appeal issued a decisionholding Shell’s Nigerian subsidiaryliable for causing oil spills in the Niger
Delta (the Nigerian farmers/Shell case).95
However, the decision also affected RDS
which was ordered by the court to installa leak detection system (LDS) in order toprevent spills in future.

7.8.10 In 2015, in an interim decision, the court
assumed jurisdiction over the matter, as
one of the defendants, RDS, is establishedin The Hague.96 The claimants usedthe Dutch parent as a so-called ‘anchor
defendant’, leading the court to assume
jurisdiction also with respect to the claims
against the non-Dutch defendants (theNigerian subsidiary, among others) due tothe connection between the claims. Shell’sarguments that the proceedings shouldhave been conducted before the Nigeriancourts because all the facts and evidence
lie there, and that the claims against RDS
seemed to be without any merit, weredismissed by the court.
7.8.11 This case is part of a wider trend where(collective) actions are brought against
non-Dutch and one or more Dutch
defendants before Dutch courts in mattersthat almost exclusively relate to a foreign
jurisdiction. When multiple parties are
involved, there is a risk that a Dutch
court will allow the claims to be brought
under the same forum in order to improve
efficiency and avoid conflicting decisions.
However, in such cases, the Dutch courts
are expected to critically assess whether
399

they have jurisdiction. A decisive factor in
the Nigeria farmers/Shell case, which led
the Dutch court to accept jurisdiction, wasprobably that the Dutch anchor defendant
was the parent company with control overits Nigerian subsidiary, and not merely
a holding company without any real ties
to the case. This enabled the claimants
to formulate a claim against the Dutch
anchor defendant that had some merit.97
7.8.12 On the basis of the case law set out above,the litigation risk for business enterprises,
especially for those that are players on
the worldwide market of fossil fuels orotherwise are responsible for (significant)greenhouse gas emissions, has increased.
Businesses, and more pertinently holding
companies, established in the Netherlands
may find themselves held liable forbreaching general duties of care forthe negative sustainability impact. We
note that, while ground-breaking, theMilieudefensie/RDS ruling is a first instancedecision and is likely to follow a long
appeal process over a number of years.
7.8.13 Apart from the applicable (international)
soft law frameworks, which in the
Milieudefensie/Shell case have effectively
been elevated into hard law principles
which can be deployed against private
actors, the number of legally binding
provisions expressly imposing liability
for negative sustainability impact for
Dutch enterprises in general is currently
limited. However, the Dutch government
has recently taken a step in this directionin the context of child labour. As in otherjurisdictions, the government has adopted
a due diligence law, the Child Labour Due
Diligence Act (Wet zorgplicht kinderarbeid)
which imposes due diligence and reporting
obligations on business enterprises selling

goods or services in the Netherlands inrelation to indications of child labour intheir supply chain.98 More recently, a newbill was also submitted to parliament
which entails due diligence obligations
covering human rights more broadly, as
well as environmental standards, andintroduces a duty of care for enterprises toprevent negative impacts on human rights
and the environment (including climate).
This Bill for Responsible and Sustainable
International Conduct (Wet verantwoord en
duurzaam internationaal ondernemen) proposes
replacing the Child Labour Due Diligence
Act which consequently may not enter
into force. However, we note that the next
steps regarding this bill are still uncertain
following the elections in March 2021.
Asset owners
7.8.14 We note that we have not yet seen civil
actions against asset owners (or against
financial institutions) associated with
their role as an investor (or financer) in abusiness enterprise that has been involvedin creating a negative sustainability
impact. While each situation needs tobe considered on its own facts, the riskof an asset owner incurring liability
for the negative sustainability impactof an enterprise in which it is invested
is, at present, generally likely to be
remote. However, as the enterprise risk
for liability for negative sustainability
impact is broadly increasing due to thedevelopments as set out above, where
an investor has a relationship with anenterprise that could result in it being
held liable for the acts and omissionsof the enterprise, the investor’s risk
may also increase, particularly where
the investor has a controlling interest
or significant influence on the policy

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
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Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGNETHERLANDSCONTENTSFOREWORDSINTRODUCTIONof the enterprise. This will be further
described below. 7.2.20. In addition to theabove-mentioned risk, we note that, as
will be described below, there have been
complaint procedures under the OECDGuidelines in the Netherlands concerning
the role of banks in relation to financing
certain business enterprises. It is possiblethat such complaints in relation to thefinancier’s duties to prevent and mitigate
negative sustainability impact could in the
future also be leveled at asset owners.
Civil liability
7.8.15 It is possible that, in certain limited
circumstances, an asset owner could
be found to have a direct duty of care
towards individuals harmed by an investee
company’s actions (or inaction) which
result in a negative sustainability impact,ie liability in negligence. Generally,
for a court to find such duty of care toexist there must be a significant level ofinvolvement and control in the day-to-day
operations of the investee company anddecision-making by the asset owner.
7.8.16 Generally, a minority shareholder (as an
asset owner would typically be) would
not typically exercise the required levelof engagement in an investee company’s
operations to attract civil liability.
7.8.17 However, we note that the relatively
limited legislative attention to negative
sustainability impact has induced
the judiciary in civil cases to take anincreasingly active role in addressing
sustainability-related problems. As
has been described above, the moststriking examples in this regard are theMilieudefensie/RDS case99, the Nigerian
farmers/Shell case100 and the Urgenda
case101 in which the Dutch courts
found RDS liable with regard to Shell’s
400

worldwide CO2 emissions and Nigerian
oil spills, and held that the Dutch state
is obliged to take additional measures tofurther reduce CO2-emissions respectively.
7.8.18 We expect that in further civil cases
against business enterprises, similararguments will be made and will be testedby the courts in the (near) future. Even
though we are not aware of similar cases
against asset owners, with the enterpriserisk for negative sustainability impact
increasing, to the extent that an investor
has a relationship with an enterprise that
could result in it being held liable for theacts and omissions of the enterprise, theinvestor’s risk is also increasing.
7.8.19 As discussed above, recent case law
indicates that liability for negative
sustainability impact could potentiallybe attributed to business enterprises or
the state on the basis of the duty of carein the context of the tort article in the
Dutch Civil Code, Article 6:162 DCC. In
addition, the approach of the courts in
the Milieudefensie/RDS and Urgenda cases
highlights the importance of ‘soft law’(such as commonly recognised industry
standards of good practice) in determining
the scope and content of the duty of care,specifically in the context of climate cases.
Even though we have not seen such civil
cases against asset owners or investment
managers, this does increase the riskof direct tortious liability for investors
for negative sustainability impact in
the relatively limited circumstances inwhich such direct liability could arise.
The risk of liability would highly dependon the circumstances of the case and inparticular on which soft law instrumentsa particular entity has committed to.

7.8.20 To our knowledge no civil claim has yet
been instituted against asset owners oragainst financial institutions associatedwith their role as an investor in a businessenterprise that has been involved increating a negative sustainability impact.
7.8.21 However, a relevant development in thiscontext is that in the past years there havebeen three complaint procedures under theOECD guidelines in the Netherlands initiatedby NGO’s against Dutch banks, one against
Rabobank and two against ING Bank.102
7.8.22 Since these involve the banks’ role inrelation to financing business enterprises,
it is easier to see how complaints of thissort could also be leveled at asset owners
and potentially play a role in subsequent
litigation against asset owners on negative
sustainability impact caused by investee
companies. If it would for instance beruled by the Dutch National OECD Contact
Point (NCP) that, on the basis of the OECD
Guidelines, an asset owner should makemore efforts to mitigate (or prevent)negative sustainable impact in relation
to certain investee companies this would
likely be a relevant factor for the court insubsequent litigation when determining
the extent to which a duty of care existed.
7.8.23 The basis for one of the complaints
against ING by a number of NGOs
was that ING is still largely financing
parties in the fossil fuel sector (eg thecoal industry), and so breaching certain
OECD principles relating to environmentand climate. The NGOs argued that ING
should publish its total carbon footprint(including indirect emissions as a resultof its loans and investments) and publish
ambitious, concrete and measurable
emission reduction targets for its loans
and investments.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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7.8.24 The procedure before the NCP resulted
in a statement by the NCP that further
dialogue between the NGOs and ING was
justified.103 While not concerning the legal
liability of ING (as the OECD standards
are not a legally binding instrument), thecase illustrates the relevance that soft law
instruments can have in establishing andrealising sustainability-related obligations.
7.8.25 The other two complaints procedures
relate to Rabobank’s and ING’s business
operations in relation to palm oil
plantations. In short, a number of NGOsargued that financial institutions like
Rabobank and ING should make more
effective efforts to mitigate or prevent theadverse impact of palm oil plantations
through their business (lending) operations.
7.8.26 In its final statement in the complaint
procedure against Rabobank the NCP interalia stated that financial institutions havea responsibility of their own to exercise
individual leverage to seek to preventor mitigate the impact of their businessconduct and respond to identified
adverse impacts through engagement or
potentially divestment. 104
7.8.27 The complaint procedure against ING is
ongoing. In January 2020 the NCP issued
a statement that the complaint merits
further consideration and that it will
facilitate a dialogue to bring parties toagreement on possible improvements of
ING’s due diligence policies and practices
regarding palm oil business financing,
and to assess its involvement with actualor potential adverse impacts in order todetermine the appropriate responses.105

401

Criminal liability

Attribution criminal law

7.8.28 In theory, it is possible that an asset owner
could be held criminally liable for theillegal conduct of a company in which it
invests. However, the hurdle for this tooccur is very high.

7.8.31 Legal entities may be liable for criminal
offences if the conduct can reasonably
be attributed to the legal entity. An
important point of orientation for
attribution is to what extent the conduct
took place or was carried out in the‘sphere’ of the legal entity. There is no
hard and fast rule, but it is establishedthat conduct may be regarded within thesphere of the legal entity, if one or moreof the following circumstances apply:(i) the conduct took place by a person
employed or working for the legal entity,(ii) the conduct was part of the legal
entity’s normal course of business, (iii) the
legal entity benefited from the conduct
and/or (iv) the conduct was at the disposalof the legal entity and such conduct
was accepted or could be said to havebeen accepted by the legal entity which
includes not exercising the care that could
reasonably be required of the legal personin order to prevent the conduct.

7.8.29 As a general rule, investors are not liable
for acts or omissions of an investee
company’s activities or operations underDutch law. Broadly, the only limited
exception to this is where it could beestablished that the asset owner had
exercised control or acted as a shadow or defacto director of the investee company. To
qualify as de facto director, the asset owner
would generally need to have substantial
involvement in the day-to-day management
and the internal decision-making of theinvestee company and in effect set aside
the formal directors of the company.
7.8.30 Generally, asset owners would not exercise
the required level of engagement in an
investee company’s operations to attract
criminal liability if it was found that an
attributable criminal offence had beencommitted at the level of the investee
company. The criterion for attribution of
liability under civil law and criminal law
are broadly the same with minor nuances(see below).

Attribution civil law
7.8.32 According to settled case law, the criterion
for attribution of tortious conduct to alegal entity under civil law is whether
the act in civil life (in het maatschappelijk
verkeer) must be regarded as the conductof the legal person taking into account all
circumstances of the case at hand.
7.8.33 In addition, in general, knowledge ofa director, is in principle attributed tothe company, unless there are specificcircumstances proving otherwise.

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B. THE EXTENT TO WHICH
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Investment managers
7.8.34 At present, the possibility that an
investment manager would be held liable
for the negative sustainability impact of thecompany it invests in on behalf of the asset
owner is generally even lower than for
an asset owner. However, here too, recent
developments may have consequences forthe likelihood of litigation.
Criminal liability
7.8.35 As to the requirements that would need
to be satisfied for an investment manager
to be held criminally liable (see paragraph7.8.28 et seq above), the likelihood thatthese conditions would be satisfied inrelation to an investment manager seems
even lower than for an asset owner.
Generally, an investment manager will
have an insufficient level of involvementwith the activities and the organisation of
the company being invested in.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

Brazil

Civil liability

Canada7.8.36 The position on the civil liability of aninvestment manager is largely similar tothat of an asset owner. The risk that an
investment manager would be held tohave breached a duty of care in relation
to the negative sustainability impact ofenterprises in which it has invested assets
of its clients is low. Indeed, in most cases
it is probably even lower than for an asset
owner since the investment manager isonly the agent of the asset owner.

China

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

402

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGNETHERLANDSCONTENTSFOREWORDSINTRODUCTION

8.

THE GROWINGIMPORTANCE OF TAKING ACCOUNT OF ESG AND SUSTAINABILITY FACTORSWHERE THESE ARE ‘FINANCIALLY MATERIAL’

8.1

It has become increasingly important
for asset owners and their investment
managers to take ESG and sustainability
factors into account in managing portfolios
because of the way in which they could
be material to achieving the financial
investment objectives of the relevant
asset owner or investment manager inaccordance with their legal duties. Some of
the main reasons are as follows:• increasing public, policy and regulatory

expectations that they should do so (further
details summarised below), which are likely
to affect the way in which legal duties areunderstood and applied in practice;• a growing trend towards sustainability-

based legal actions where businessenterprises and others are seen as having
contributed to sustainability challenges;• greater knowledge of the risks thatsustainability factors can pose to portfolio
performance, particularly in the areaof climate change but also as a resultof the COVID-19 pandemic, and theopportunities that they can provide;• greater awareness of the speed with whichsome sustainability risks may
be materialising;• improving disclosure regimes, making it

more feasible to understand the role ofindividual business enterprises in
helping to realise or in undermining
sustainability goals;• growing availability of good-quality

investment analysis of the risks posed
to business enterprises by sustainability
factors and potential opportunities;403• growing expertise and developing conceptual

frameworks in the areas of sustainability
assessment and the investment management
expertise needed to take greater account ofsustainability in the investment process; and• the development of investor alliances andcoalitions making it easier for investors toaddress sustainability risks.
8.2

Political, regulatory and public expectations
that asset owners and their investment
managers should take account of ESG andsustainability factors in the investment
process have grown considerably in recent
years.106 This is partly due to changing
sentiment in society and is evidence of a
growing realisation in the Netherlands
that an exclusive focus on shareholder
value fails to take sufficient account of theinterests of those affected by a company
and the role of a company within society.
These expectations may not always beframed in terms of IFSI since the conceptof ‘sustainable investing’ covers such a
broad waterfront ([see Part I, Section A ofthe main report]). However, it is nonethelessclear that there is a growing belief that
ESG and sustainability factors need greaterattention in the way investment portfolios
are managed and run. Not only are
independent bodies such as Eumedion andinvestment beneficiaries calling for ESG
and sustainability factors to be taken more
fully into account in managing investment
portfolios, but it has also become a focus ofattention among national and international(European) authorities. Heightenedawareness of the risks from sustainability
factors to portfolio performance make it
crucial for those responsible for managing
investment portfolios to consider how ESG

and sustainability factors could be relevant
to achieving the investment objectives ofthe portfolio and, where appropriate, to act.
Governmental activity relevant to sustainability
and ESG in the investment process
8.3

In August 2019, the Dutch government
announced its strategy to improvesustainability and reduce the risks ofclimate change. The three main pillars
are: (i) encouraging financial institutions
to incorporate the impact of climatechange into their policies, looking at theopportunities and risks related to climate
and the energy-transition; (ii) improving
transparency about the impact of climatechange in business and financial enterprises
and normalising the incorporation ofclimate impact in business and financial
decision-making; and (iii) accumulating andsharing experience on ‘green’ financing, forwhich the government is seeking national
and international cooperation.107 Financial
institutions are expected to inform theDutch government by the end of 2020of their action plans on contributing to
the reduction of CO2 emissions. Also, in2019 the Dutch government issued thefirst ‘green’ government bond to advancesustainability on the capital market.
Furthermore, several members of the Dutch
House of Representatives have recently
launched an initiative suggesting that there
is a need to focus on (i) reducing investment
in polluting products; and (ii) investigating
how the financial impact on big companiesof growing biodiversity and climate risks
can best be shared.108

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGNETHERLANDSCONTENTSFOREWORDSINTRODUCTION

Academic activity relevant to sustainability
and ESG in the investment process
8.4

8.4.1

404

Academic attention to the place of ESG
goals within the existing legal framework
has also intensified in recent years. In
2021, 25 Dutch business law professors
have proposed new legislation. They havesuggested that the Dutch company law
regime should be amended to reflect
the expectation that companies need todischarge their social responsibilities.109
They claim that the COVID-19 crisis has
refocused public attention on the social
responsibilities of companies. They argue
that the level of social responsibilityof, among others, Dutch companies,
is heightened now that part of theentrepreneurial risk these companies would
normally carry has fallen on the public intimes of crisis (eg through state support).
They have suggested amending the Dutch
Civil Code to introduce a legal basis for‘responsible corporate citizenship’. This
would include directors of Dutch (listed
and unlisted) legal entities being legallyobliged to not only serve the interestsof the company, but also procure thatthe company’s relationship with wider
society is conducted in a responsible way.
Furthermore, they have suggested that the
DCC should explicitly state that companies
can have a business purpose that promotes
such socially responsible engagement.
Lastly, all legal entities would be obliged toreport in their annual reporting how they
have engaged in a socially responsible way
and illustrate which activities have been
undertaken to support the community,
the environment and the climate. This
reporting obligation may not be a novelty
for some types of (regulated) companies but
goes further than the existing rules. The

DCC currently does not prohibit a company
from doing any of these things andcertainly in practice many listed companies
are already doing so, as also provide for in
the Corporate Governance Code. However,
it is argued that that explicitly includingthese tools into the DCC would provide animportant signal of a wider move in a moresustainable direction.110
8.4.2

great financial resources are required,in which the AFM expects financial
institutions to play an active role – in otherwords, the AFM has identified a purpose forfinancial activity which involves achieving
sustainability impact goals.
8.6

Questions have been raised about thepractical enforceability of legislation of thissort; the risk of a ‘tick-the-box mentality’;and as to the scope of what should be
regarded as ‘socially responsible’.111
However, growing discussion of thesepoints suggests that the legal rules may
soon change in ways that require greaterattention to the social purpose of business.
Regulatory activity relevant to sustainability
and ESG in the investment process

8.5

As noted previously, earlier this year
the AFM published a position paper onsustainability.112 In it, the AFM statesthat it expects financial institutions
to integrate and be transparent aboutsustainability issues in their business
operations, including in the area of productdevelopment, risk management andinvestment decisions. This expectation
includes informing consumers andother beneficiaries of the possibility ofincorporating sustainability factors intheir financial (investment) decisions
and products. The AFM stresses that thefinancial sector plays an important rolein the transition to a sustainable society,to mobilise capital from governments,
businesses and consumers towards
sustainable investments. To reach theDutch government’s goal of emitting 49 percent less CO2 in 2030 and Europe becoming
climate neutral by 2050, great effort and

8.7

The AFM notes the growth in financial
products and services with sustainability
characteristics: institutional investors aswell as consumers have a growing interestin these products. It indicates that there
are two main points of focus in the AFM
supervisory mandate in this area: (i)sustainability aspects being incorporated
in financial products in a responsible andprudent way, while remaining compliant
with legal requirements to protect andinform consumers and beneficiaries; and (ii)providing the information that consumers
and investors need to take well-informed
decisions, which includes being transparent
about the extent to which products are
sustainable and how they contribute to ESG
objectives (ie the sustainability impact they
are designed to achieve).
The DNB has also issued a number of
research reports and other publications
on climate-related financial risks andsustainable investment in the Dutch
pension sector in recent years.

Practice
8.8

The Federation of Dutch Pension Funds
is developing similar initiatives, which
encourage its members to conduct a
responsible investment policy. For instance,
APG and PGGM – considered the two largest
pension funds in the Netherlands – havelaunched several sustainability projects
related to their investment policy, such asa sustainable investing platform for asset
owners, thereby setting a (high) standard
for other pension funds and asset owners.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGNETHERLANDSCONTENTSFOREWORDSINTRODUCTION

9.

TIME HORIZON OF INVESTMENTS IN PRACTICE

9.1

In practice, an asset owner may findits performance judged by reference torelatively short time periods, both as acommercial matter and by reference tolegal duties. There are various reasonsfor this. First, it is challenging to assess
progress towards a long-term goal except
by looking at shorter-term performance.

9.2

405

Secondly, the situation is further
complicated by the fact that longterm investors may need to accessthe expertise of investment managers
who are appointed under investment
management agreements, the term ofwhich is generally much shorter than
the investment time-horizon of the asset
owners appointing them. The investment
manager’s own performance is then likely
to be judged by reference to the financial
performance of the portfolio over that
period or even shorter periods. In thiscontext, the legal terms of the contract
may therefore effectively set shorterterm goals, so that financial materiality
comes to be judged by reference to these.
The relatively long time it takes for the
positive financial impact of environmental
factors (and some sustainability factors
more broadly) to show therefore involves
a risk for investment managers seeking
to base investment decisions on them.
With an investment horizon of 10 years
or more, for example, an investment
manager making a decision based on along-term sustainability factor may proveto have been right. However, a standard
evaluation period for an investment
strategy and investment returns is three
years or less; over that period there could
be underperformance. This then brings intoplay a complex mixture of incentives.

It could have an impact on the firm’s
or the individual portfolio manager’s
compensation (for example, the manager
might miss out on variable performancerelated pay), funds could be withdrawn
from the portfolio, the mandate could
be terminated on the basis of poor
performance or an investment
manager’s personal involvement inmanaging a portfolio could be terminatedfor similar reasons.
9.3

Several working groups (such as theWorking Group on the Integrity ofPension Funds under the chairmanshipof Jean Frijns113) have considered thepossibility that the standard investment
policy will result in too much attention
to the short-term and result in a tendency
to follow ‘the market’ because the market
is as of yet unable to assess the valueof the long-term sustainability risks
correctly. Assessing financial materiality
by reference to shorter-term goals mayhelp to protect a portfolio from shorterterm sustainability risks within investee
enterprises and realise opportunities. In
doing so, in some cases, this may also
have results that are similar to thosethat would be realised by IFSI. However,it seems likely that many, if not most,investment risks and opportunities arisingfrom sustainability factors are likely to
crystallise within a longer timeframe.

ACKNOWLEDGEMENTS

Marit Balkema, Michael Broeders, Igor
Dovgaliouk, Hakan Gargili, Charlotte Kriekaard,
Maxine Lemstra, Sharon Sloof and Marco Vogels
Barbara Slooter

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGNETHERLANDSCONTENTSFOREWORDSINTRODUCTION
1
2

3

4

5

SWFI Institute, ‘Top 100 Largest Public Pension Rankings by Total
Assets’ (https://www.swfinstitute.org/fund-rankings/public-pension).
Representative associations of employers and employees havetogether with the government agreed on an adjustment to theexisting pension system with a view to ensuring its future viability.
The intension is to develop a new legislative framework which is tobe presented shortly, but not yet available, which would become
effective on 1 January 2022 and would require pension funds tocommence transition to the new system on 1 January 2024. The
transition phase would end on 1 January 2026. One of the newfeatures is that beneficiaries will have more flexibility in choosing
a particular type of pension, including by opting for a ‘green
pension’ or a ‘pension which is created through sustainable andfairer investing’. The introduction of these choices will impact on
the obligations of the fund vis-à-vis the beneficiary, including on
assisting the beneficiary in making the right choices, providing
information, the application of the prudent person rule and liabilityof the fund. The legislative framework will also include requirements
for lifecycle investing, requiring appropriate consideration of
investment risk in relation to beneficiaries’ age and retirement
date, with investment risk decreasing closer to the retirement date.
Another important change will be that the system whereby younger
participants and older participants all pay the same contributions,
resulting in a transfer of value from younger participants to older
participants, will be phased out. This raises complicated issues forthe transition phase where the middle-aged participants are at
risk of carrying the largest burden as they – without compensation– would neither have the benefits of the new or the old system.
Compensation to the middle group can be paid over a periodof 10 years. One of the other changes considered includes theabolishment of the use of notional interest (rekenrente) to calculate
the present value (contante waarde) of future obligations, which inpractice may potentially provide pension funds with more flexibility
as to the substance of their investment policy.
Under the Dutch Pensions Act (Pensioenwet), a pension fund isconsidered Dutch if its seat is in the Netherlands. However, underarticle 199 Dutch Pensions Act, pension funds seated in othermember states may implement pension schemes for Dutch
beneficiaries provided (i) they are licensed in another member
state, and (ii) have notified the relevant supervisory authority of theother member state. Foreign pension funds implementing pension
schemes for Dutch beneficiaries are obliged to take Dutch social
security and employment laws into account whilst implementing
the pension schemes (article 199a Dutch Pensions Act). In thismemorandum we consider only Dutch pension funds, ie those with
their seat in the Netherlands.
Court of Amsterdam 19 January 2018, PJ 2018/114 with annotation
by V. Gerlach. See also regarding the application of the prudent
person rule, Court of Rotterdam, 25 April 2013, JOR 2013/178 (DNB
– Pf J&J) annotation by J.A. Voerman and court of Rotterdam 16
February 2015, ECLI:NL:RBROT:2015/53 with annotation by I. Witteand CBp 10 September 2013, JOR 2013/312 annotation by S.H.
Kuiper and J.A. Voerman.
Rene Maatman & Esther Huijzer, 15 years of prudent person rule,in Sustainability and Financial Markets, Deventer 2019, page. 266
with reference to CBp 10 September 2013, JOR 2013/312 withannotation by S.H. Kuiper and J.A. Voerman. See Also V.P.G. deSerière, Ondernemingsrecht, 2020, 12.

6Rene Maatman & Esther Huijzer, 15 years of prudent person rule, in
Sustainability and Financial Markets, Deventer 2019, page. 281.

7

V.P.G. de Serière, Ondernemingsrecht, 2020, 12.

8

V.P.G. de Serière, Ondernemingsrecht, 2020, 12.

9V.P.G. de Serière, Ondernemingsrecht, 2020, 12.

10Rene Maatman & Esther Huijzer, 15 years of prudent person rule, in406

Sustainability and Financial Markets, Deventer 2019, page. 264.
11

Rene Maatman & Esther Huijzer, 15 years of prudent person rule, in
Sustainability and Financial Markets, Deventer 2019, page. 265.

12

V.P.G. de Serière, Ondernemingsrecht, 2020, 12 and https://pensioenfederatie.nl/website/publicaties/servicedocumenten/codepensioenfondsen-2018.

13

R.M. Maatman, The Prudent person-rule, duty of care and the new
pension contract, Journal of Company Law, 2017/135, including withreferences to further literature.

14

Dutch Supreme Court, JOR 2009/199, r.o. 4.11.

15

L. Timmerman, Liability of directors and supervisory directors (VDHI
nr. 140), 2017/2.7.

16

See the Dutch Anti-Money Laundering and Anti-Terrorism Financing
Act (Wet ter voorkoming van witwassen en financieren vanterrorisme), the Dutch Sanctions Act 1977 (Sanctiewet 1977) andministerial regulations (ministeriële regelingen) promulgatedthereto. Further, also refer to section 21a of the Dutch Decree on
Market Abuse DFSA (Besluit marktmisbruik Wft) regarding theprohibition to invest in cluster munition.

17

Rene Maatman & Esther Huijzer, 15 years of prudent person rule, in
Sustainability and Financial Markets, Deventer 2019, page. 281.

18

Rene Maatman & Esther Huijzer, 15 years of prudent person rule,in Sustainability and Financial Markets, Deventer 2019, page. 264,with reference to the report ‘Kijken in Spiegel” pp. 27ff. The working
group responsible for drawing up the report took into account thatthe investment policy will devote too much attention to short term
and following the market because the market is unable to assess thevalue of the long term ESG risks correctly and further literature.

19

See DNB, Sustainable investment in the Dutch pension sector
https://archief20.archiefweb.eu/archives/
archiefweb/20161014152700/https:/www.dnb.nl/en/binaries/
Sustainable%20investement%20in%20the%20Dutch%20
pension%20sector_tcm47-346418.pdf?2020102815

20

DNB, Sustainable investment in the Dutch pension sector, p. 27.

21

R.H. Maatman, The Prudent person rule, duty of care and the new
pension contract, Journal for Company law, 2017/135.

22This follows from the text and rationale of article 135(1) DPA. See
also Rene Maatman & Esther Huijzer, 15 years of prudent person
rule, in Sustainability and Financial Markets, Deventer 2019, page.
283.

23

J.H. Langbein et al, Pension and Employee benefit law. St. Paul
2015, p. 507. See also J.M.G. Frijns et al., Transparancy International,
Looking in the mirror (2013) and article 18 Pension Directive.

24

Rene Maatman & Esther Huijzer, 15 years of prudent person rule, in
Sustainability and Financial Markets, Deventer 2019, page. 283.

25

Rene Maatman & Esther Huijzer, 15 years of prudent person rule, in
Sustainability and Financial Markets, Deventer 2019, page. 285.

26

See DNB, Sustainable investment in the Dutch pension
sector, p. 32 (https://archief20.archiefweb.eu/archives/
archiefweb/20161014152700/https:/www.dnb.nl/en/binaries/
Sustainable%20investement%20in%20the%20Dutch%20
pension%20sector_tcm47-346418.pdf?2020102815 where DNB
explicitly states: ‘In our study, we looked at potential obstacles tosustainable investment originating in rules and regulations or
supervision. This has as yet not resulted in any specific follow-up
steps, but we continue to be receptive to signs from the sector.
Pension funds are responsible for defining what sustainability
means to them and how they intend to put it into practice,
motivated by their ambitions as well as risk management
considerations. They are encouraged to do so by current
legislation. The prudent person principle leaves ample scope todesign sustainable investment policies, provided that they arecompatible with the fund’s objectives and in the members’ interestand the investment portfolio is sufficiently diversified. Pension
funds basing their operations on sustainability are expected toembed this principle in the elaboration and implementationof their investment policies and to be transparent about theirsustainable investment activities. Another key aspect is the match
between a pension fund’s management and expertise and thenature of its investments, which, naturally, also applies to nonsustainable investments.’
27

DNB ‘Sustainable investment in the Dutch pension sector’,September 2016, p. 33 (https://archief20.archiefweb.eu/archives/
archiefweb/20161014152700/https:/www.dnb.nl/en/binaries/
Sustainable%20investement%20in%20the%20Dutch%20
pension%20sector_tcm47-346418.pdf?2020102815).

28

Directive (EU) 2016/2341.

29		See for example for an illustration of this issue Volkskrant May 1,
2021, Koen Haegens, Does your pension fund also invest in harmful
businesses? and Volkskrant May 4, 2021, Hans van Meerten &Hanine Al-Nassar, Harmful Investment by your Pension fund, takethem to court.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

30

See, for example, the report of APG (Verslag verantwoord beleggen)page 11, which can be consulted at https://apg.nl/media/o2kdbas4/
nl-verslag-verantwoord-beleggen-apg-2019-2020_1.pdf).

31

https://www.pggm.nl/en/press/us-1-trillion-asset-owner-platformlaunches-solution-for-identifying-sdg-investments/ (accessed 24
October 2020).

32

ABP Sustainable and responsible investment policy 2020-2025(https://www.abp.nl/images/summary-sustainable-and-responsibleinvestment-policy.pdf).

33

PMT Strategic Investment Framework 2020-2022 (https://www.pmt.nl/media/lguj3nrk/pmt302e_strategic_investment_
framework_2020-2022.pdf)

34

Directive 2009/65/EC of the European Parliament and the Councilof 13 July 2009 on the coordination of laws, regulations andadministrative provisions relating to undertakings for collective
investment in transferable securities, OJ L 302, p. 32

35

Directive 2011/61/EU of the European Parliament and the Councilof 8 June 2011 on Alternative Investment Fund Managers andamending Directives 2003/41/EC and 2009/65/EC and Regulations(EC) No 1060/2009 and (EU) No 1095/2010, OJ L 174, 1.7.2011, p.
1–73

36

This report does not consider requirements under any particularexchanges.

Netherlands

37

Please refer to the EU section of this report for further detail on
investor protection in the context of UCITS.

South Africa

38

An insurance undertaking can take various legal forms, including aform of cooperative association (cooperatie), or an NV (Naamloze
Vennootschap, public limited liability company) or BV (Besloten
Vennootschap, private limited liability company)

United Kingdom

39

See Sections 2:129(5) and 2:140(2) DCC in respect of Dutch public
limited liability companies (naamloze vennootschappen).

40

See Dutch Supreme Court (Hoge Raad), 4 April
2014, NJ 2014/286; JOR 2014/290 (Cancun).

41

See Section 2:8 DCC, See also Dutch Supreme Court (HogeRaad), 4 April 2014, JOR 2014/290 m.nt. R.G.J. de Haan
(Cancun), and (Hoge Raad), 9 July 2010, NJ 2010/544 (ASMI),
12 July 2013, NJ 2013/461 (VEB c.s. / KLM) and 14 September
2007, NJ 2007/610 (Versatel I).

42

Article 2:135a paragraph 6 DCC.

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGNETHERLANDSCONTENTSFOREWORDSINTRODUCTION
43

J.W. Winter, J.M. de Jongh, J.B.S. Hiijink. L. Timmerman, G. van
Solinge and L.M. Lennarts, To a duty of care for directors andsupervisory directors for responsible participation to society, Journalfor Company Law, 2020, nr. 7, 86 and also P.F. van der Heijden,
Eastern winds, or: from soft law to hard enforcement action,
Ondernemingsrecht, 2021, 2.

44

H.J. de Kluiver, On the responsible conduct of a business, towards a
Paradise by the dashboard light. Journal for Company Law, 2020, nr.
13/14, 126

45

Code of 8 December 2018, www.mccg.nl.

46This article provides that more detailed requirements can be
imposed for the annual report on compliance with, amongst otherthings, a code of conduct to be designated by an order in council.
On 7 September 2017, the publication of the designation order(Stb. 2017, 332) in the Dutch Bulletin of Acts and Decrees legallyenshrined the Code 2016 as of 1 January 2018.

47

See the preamble of the Netherlands Corporate Governance Code(unofficial English translation, p. 7). (link)48

See ‘Compliance with the Code’, Netherlands Corporate Governance
Code (unofficial English translation, p. 11). (link)49

See ‘Compliance with the Code’, Netherlands Corporate Governance
Code (unofficial English translation, p. 11). (link)50

See ‘Compliance with the Code’, Netherlands Corporate Governance
Code (unofficial English translation, p. 11). See also R.T.L. Vaessen,‘Bestuurdersaansprakelijkheid en corporate governance’, MvV 2017,
afl. 12, p. 322. (link)

51

R.H. Kleipool e.a., Commentaar & Context Corporate Governance
Code, Den Haag: Boom Juridisch 2019, p. 30. (link)52

See the preamble of the Netherlands Corporate Governance Code(unofficial English translation, p. 7). (link)53

See the relevant sections in the DFSA, Decree on Prudential Rules(Besluit prudentiële regels) and Decree on Conduct Supervisionof Financial Undertakings (Besluit Gedragstoezicht financiële
ondernemingen).

54

Directive 2009/138/EC of the European Parliament and of theCouncil of 25 November 2009 on the taking-up and pursuit of thebusiness of Insurance and Reinsurance (Solvency II).

55

Commission Delegated Regulation (EU) 2015/35 of 10 October 2014
supplementing Directive 2009/138/EC of the European Parliamentand of the Council on the taking up and pursuit of the business of
Insurance and Reinsurance , OJ L 12, p. 1-797.

56

Kamerstukken II 2016/17, 34583, nr. 3, p. 33 and Stb. 2018, 147.

57

COM/2018/097 final

58

Final version of amended delegated act 2017/565: mifid-2delegated-act-2021-2616_en.pdf (europa.eu)

59

Final version of amended delegated act 2017/2359: https://
eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=PI_
COM:C(2021)2614&from=EN

60

Paragraph 28 ESMA Guidelines on certain aspects of the MiFID II
suitability requirements.

61

ESMA Consultation paper on integrating sustainability risks andfactors in MiFID II, p. 23.

62

ESMA Final report on integrating sustainability risks and factors in
MiFID II, p. 9.

63https://www.asrnl.com/-/media/files/asrnederland-nl/duurzaamondernemen/duurzame-belegger/sustainable-investing-code.
pdf?la=en64

https://www.imvoconvenanten.nl/en/insurance/convenanten.

407

The Dutch non-life and life insurance sector currently manages
some €500bn for insured parties. A large part of this is invested
in shares, in loans to public authorities and businesses, and in realestate. Some of it is invested outside the Netherlands. With the
IRBC Covenant the industry does not only want this to be safeand profitable, but also to be invested responsibly. According to
the explanation to the agreement, the agreement creates theopportunity to exert influence and to prevent and tackle problems
within the chain. Also, the explanation states that with the newagreement, Dutch insurers are the first in the world in this sector toenter into a broader and more ambitious agreement that addresses
issues relating to the environment and social aspects such as
corporate governance. The commitments in the agreement are
based on the OECD Guidelines for Multinational Enterprises and the
UN Guiding Principles on Business and Human Rights; among otherthings the agreement also promotes animal rights.
65

It is, however, advocated that a stakeholder approach is not sufficient
to take social and ecological aspects into account in a full andbalanced way. See D. Schoenmaker, ‘Een financiële sector ten
dienste van een duurzame economie’, FR 2020, afl. 10, p. 465. (link)66

https://www.abp.nl/images/stewardship-beleid.pdf

67

https://www.abp.nl/images/abp-verslag-duurzaam-beleggen-2019.
pdf

68https://www.pmt.nl/media/whqdwfgs/samenvatting_verantwoord_
beleggen_beleid.pdf

69

https://www.pmt.nl/media/ygucljvb/pmt_verantwoord_beleggen_jaarverslag_201970

https://www.imvoconvenanten.nl/en/pensionfunds/partijen

71

https://www.vbdo.nl/en/2020/10/dutch-pension-funds-challenged-totranslate-sustainable-policy-into-practice/72

See https://www.eumedion.nl/nl/public/kennisbank/bestpractices/2017-09-consultatiedocument-stewardship-code.pdf. The
Dutch Stewardship Code is based on the provisions regarding theshareholders’ engagement from the revised EU Shareholder Rights
Directive II.

73

See https://www.eumedion.nl/nl/public/kennisbank/bestpractices/2017-09-consultatiedocument-stewardship-code.pdf. The
Dutch Stewardship Code is based on the provisions regarding theshareholders’ engagement from the revised EU Shareholder Rights
Directive II.

74

See paragraph [2.3.44].

75

3:267h of the DFSA in conjunction with Chapter 12.2 of the Decree
on Prudential Rules (Besluit prudentiële regels Wft).

76

IRBC paragraph 4, link to Dutch version: https://www.
imvoconvenanten.nl/-/media/imvo/files/verzekeringssector/
convenant-verzekeringssector.pdf

77

See also L.J. Silverentand en F.W.J. van der Eerden (red.), Hoofdlijnen
Wft (Recht en Praktijk nr. FR6), Deventer: Wolters Kluwer 2018, p.
115.

78

For the definition of a UCITS (icbe), please refer to Section 1:1 of the
DFSA. Although not explicitly reflected in the definition itself, themain goal of a UCITS is normally presumed to enable a financial
return for its unit holders.

79

Please refer to Section 4:49(2) DFSA in conjunction with Section 118
of the Decree on Conduct Supervision of Financial Institutions under
the DFSA (Besluit Gedragstoezicht financiële ondernemingen Wft(BGfo)) in respect of the general prospectus content requirementsfor UCITS.

80

European Parliament and of the Council as regards organisational
requirements, conflicts of interest, conduct of business, risk
management and content of the agreement between a depositary
and a management company.
81

See Section 91(4) BGfo.

82

See the AFM’s position paper “AFM en duurzaamheid” dated June
2020, page 13.

83

See ESMA’s Guidelines on MiFID II product governance requirements(ESMA35-43-620) of 5 February 2018, page 7.

84		ESMA Guidelines on certain aspects of the MiFID II suitability
requirements (2018), paragraph 28, and also statement from theEuropean Commission that firms “should ask about their clients’preferences (such as environmental, social and governancefactors) and take them into account when assessing therange of financial instruments and insurance products to berecommended” See also para [above].
85		[Final version COMMISSION DELEGATED REGULATION (EU) …/...
of 21.4.2021 amending Delegated Regulation (EU) 2017/565 as
regards the integration of sustainability factors, risks and preferences
into certain organisational requirements and operating conditions
for investment firms (June 2020).][check for updates ahead of
publication]
86

Examples of cases include Amnesty International cs. vs.
Government of the Netherlands (https://www.amnesty.nl/content/
uploads/2020/02/Press-Release_Dutch-border-police-in-courtfor-ethnic-profiling.pdf?x48668). In this case, the Dutch state wassummoned for alleged ethnic profiling by the Dutch border police
during border control operations. We also refer to Kiobel cs. vs.
Shell cs. (ECLI:NL:RBDHA:2019:4233) in which case four widows
held several entities within the Shell group liable for not preventing
the execution of their spouses (the Ogoni 9) in Nigeria in 1995. The
Ogoni 9 was a group of nine environmental activists who opposedto the oil-pollution by Shell in the Niger Delta. On 1 May 2019 theDistrict Court of the Hague accepted jurisdiction and ordered theplaintiffs to provide evidence.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaMilieudefensie cs., vs. Shell cs. (https://en.milieudefensie.nl/
shell-in-nigeria), in which case Friends of the Earth Netherlands(Milieudefensie) together with four Nigerian farmers, initiatedlitigation in 2018 against Shell and its Nigerian subsidiary Shell
Petroleum Development Company (SPDC) for alleged pollution offish ponds and soil by oil spills in the Niger Delta.

China

88

Urgenda Foundation vs. Government of the Netherlands(ECLI:NL:HR:2019:2006), as well as Milieudefensie et al.
vs. Royal Dutch Shell plc (ECLI:NL:RBDHA:2021:5337 and
ECLI:NL:RBDHA:2021:5339).

Japan

89

Examples of soft law instruments include: the UN Guiding Principles
on Business and Human Rights; the United Nations Global Compact;
the OECD Guidelines; Responsible business agreements (in Dutch:
IMVO convenanten); the Equator Principles; and various mission
statements, internal codes of conduct and commitments ofenterprises

South Africa

87

90

91

European Union
FranceNetherlands

United Kingdom
United States

The Hague District Court 26 May 2021 Friends of the Earthand others v. Royal Dutch Shell plc (ECLI:NL:RBDHA:2021:5337
and ECLI:NL:RBDHA:2021:5339). For the English versionof the judgment, see: https://uitspraken.rechtspraak.nl/
inziendocument?id=ECLI:NL:RBDHA:2021:5339.

GLOSSARY

Urgenda Foundation v. Government of the Netherlands(ECLI:NL:HR:2019:2006).

REFERENCES

See Section 4:61(1) DFSA in conjunction with Section 126j BGfo,
implementing Article 22(3) of Commission Directive 2010/43/
EU of 1 July 2010 implementing Directive 2009/65/EC of theFreshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGNETHERLANDSCONTENTSFOREWORDSINTRODUCTION
92

93

In interpreting the specific unwritten duty of care that applies to
RDS, the court used the following circumstances: (a) Articles 2 and
8 of the European Convention on Human Rights which guarantee
the right to life (Article 2) and rights to a private life, family life,
home, and correspondence (Article 8); (b) the equivalent rights in
the International Covenant on Civil and Political Rights (Articles 6
and 17); (c) the climate goals of the Paris Agreement; (d) scientificevidence on the dangers of climate change of the United Nations
panel on Climate Change; (e)the UN Guiding Principles
on Business and Human Rights (the UNGPs), and (f) the OECD
Guidelines for Multinational Enterprises.
RDS reports on greenhouse gas emissions on the basis of the World
Resources Institute Greenhouse Gas Protocol (GHG Protocol). The
GHG Protocol categorises greenhouse gas emissions in Scope 1, 2
and 3: Scope 1: direct emissions from sources that are owned orcontrolled in full or in part by the organisation; Scope 2: indirectemissions from third-party sources from which the organisation haspurchased or acquired electricity, steam, or heating for its operations;and Scope 3: all other indirect emissions resulting from activitiesof the organisation, but occurring from greenhouse gas sources
owned or controlled by third parties, such as other organisations
or consumers, including emissions from the use of third-party
purchased crude oil and gas.

94

Kouwenberg/Rabobank (ECLI:NL:HR:2003:AF7419).

95

Greenpeace/Dutch State (ECLI:NL:RBDHA:2020:12440).

96

Nigerian farmers/Shell (ECLI:NL:GHDHA:2021:132).

97

Nigerian farmers/Shell (ECLI:NL:GHDHA:2015:3588).

98

The recent Dutch Act on redress of mass damages in a collective
action (WAMCA), which allows a claim vehicle to claim monetarydamages on behalf of injured parties, does however include alimited-scope rule preventing the Netherlands becoming too
popular a forum for collective actions without sufficient nexus with
the Netherlands.

99

Similarly to legislation such as the UK Modern Slavery Act and theFrench ‘duty of vigilance’, the law inter alia requires companies to
produce a statement, in this case attesting that they have carried out
a certain level of due diligence in their entire supply chains.

100

The Hague District Court 26 May 2021 Friends of the Earthand others v. Royal Dutch Shell plc, (ECLI:NL:RBDHA:2021:5337
and ECLI:NL:RBDHA:2021:5339). For the English versionof the judgment, see: https://uitspraken.rechtspraak.nl/
inziendocument?id=ECLI:NL:RBDHA:2021:5339.

101

Nigerian farmers/Shell (ECLI:NL:GHDHA:2021:132).

102

Urgenda Foundation v. Government of the Netherlands(ECLI:NL:HR:2019:2006).

103

Milieudefensie et al. vs Rabobank (https://www.oecdguidelines.nl/
documents /publication/ 2016/1/15/fs-foe-milieudefensie-rabobank),
Milieudefensie et al. vs. ING (https://www.oesorichtlijnen.nl/
documenten/publicatie/2020/01/20/initial-assesment-friends-ofthe-earth-vs.-ing) and 4 NGO’s v ING https://www.oecdguidelines.nl/
documents/publication/2019/04/19/ncp-final-statement-4-ngos-vsing

104

4 NGO’s v ING https://www.oecdguidelines.nl/documents/
publication/2019/04/19/ncp-final-statement-4-ngos-vs-ing

105

Milieudefensie et al. vs Rabobank (https://www.oecdguidelines.nl/
documents /publication/2016/1/15/fs-foe-milieudefensie-rabobank)106

Milieudefensie et al. vs. ING (https://www.oesorichtlijnen.nl/
documenten/publicatie/2020/01/20/initial-assesment-friends-of-theearth-vs.-ing)

107

F. Beekhoven van den Boezem, C. Jansen & B.A. Schuijling (red.),Sustainability and financial markets (Law of Business and Finance408

volume 17), Deventer: Wolters Kluwer 2019, p. 273.
108

Letter Ministry of Finance dated 29 August 2019 (Parliamentary
Documents II 2018-2019, 32013, no. 220).

109

Initiative policy document ‘Van oliedom naar gezond verstand:verduurzaming van de financiële sector’ (Parliamentary Documents
II 2020-2021, 35446, no. 2).

110

J.W. Winter et al., ‘Naar een zorgplicht voor bestuurders
en commissarissen tot verantwoorde deelname aan het
maatschappelijk verkeer’, Ondernemingsrecht 2020/86.

111

J.W. Winter et. al., ‘Naar een zorgplicht voor bestuurders
en commissarissen tot verantwoorde deelname aan het
maatschappelijk verkeer’, Ondernemingsrecht 2020/86.

112

K.A.M. van Vught, ‘Gaan de tijden veranderen?’, Weekblad voor
Privaatrecht, Notariaat en Registratie 2020/7291.

113

AFM position paper ‘AFM en duurzaamheid’, June 2020 (available athttps://www.afm.nl/~/profmedia/files/onderwerpen/duurzaamheid/
position-paper-afm-duurzaamheid.pdf?la=nl-nl).

114

Working Group on the Integrity of Pension funds, ‘Kijken in deSpiegel’ (‘Looking in the Mirror’), available for consultation at https://www.transparency.nl/wp-content/uploads/2016/12/TI-NL-Kijken-inde-spiegel.pdf.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION

1.

INTRODUCTION

1.1

This Annex considers the extent to which
IFSI is required, or may be permitted,
under the laws of South Africa as at
31 January 2021. As discussed in themain body of the report, the expression‘Investing for Sustainability Impact’ (IFSI)
is not a precisely defined legal expression,and it is important to emphasise that
South African law does not reference
it in that way. Rather, the expression isused here as a type of ‘conceptual net’ tocatch any approach on the part of Asset
Owners or their Investment Managers
that involves intentionally seeking, either
through instrumental IFSI or ultimate
ends IFSI (each as described below andin more detail in Part A), to increase thepositive Sustainability Impact and reduce
the negative Sustainability Impact ofinvestee enterprises.

1.2

409

There is a distinction drawn in thisAnnex between “instrumental IFSI”
and “ultimate ends IFSI”. Instrumental
IFSI is where achieving the relevant
sustainability impact is ‘instrumental’ inrealising the investor’s financial return
goals, for example, where an investor
concludes that its financial return goals
may not be realised (and beneficiaryinterests damaged) unless a particularsustainability outcome can be achieved
and the particular Sustainability Impact
sought can help with that. Ultimate
ends IFSI is where achieving the relevant
Sustainability Impact is a goal in its own
right, pursued alongside the investor’s
financial return objectives, but not as ameans to achieving them. There may besome overlap between the two, but the
key distinction between instrumental
IFSI and ultimate ends IFSI is that the

ACKNOWLEDGEMENTS

latter involves the pursuit of particular
Sustainability Impacts as an end in and of
itself, rather than as a means to achieving
targeted financial returns.
1.3

1.4

1.4.1

The investment and stewardship activities
of Asset Owners and Investment Managers
are shaped by legal and regulatory
obligations and guidance, industry andmarket practice, and stewardship codessuch as CRISA and the UN PRI. They arealso often informed and prescribed byindividual agreements concluded between
Investment Managers and Asset Owners.
This Annex does not set out detailed
analysis nor address all potentiallyrelevant issues or rules, but rather
provides a high level overview of andcommentary on the legal framework
generally applicable to IFSI by certain
Asset Owners and Investment Managers inSouth Africa. It is no substitute for legal
advice in individual circumstances.
This Section 1 briefly touches on certain
aspects of the context applicable to
IFSI in South Africa: the legal context;
National Treasury’s Sustainable FinanceInitiative; the responsible investment
and stewardship code, CRISA; and thecorporate governance codes, King IV.
Sections 2 to 4 address the ability ofAsset Owners to IFSI where the relevant
portfolio does not have an express
Sustainability Impact objective. Section
5 looks at the possibility of establishingfunds to Invest for Sustainability Impact
and amending the terms of existing ones.
Section 6 considers Investment Managers’
duties to IFSI. Section 7 addresses theissue of legal liability to third parties
for the negative Sustainability Impact
of enterprises in which portfolios areinvested. Lastly, Section 8 briefly touches
on the growing importance of taking
account of ESG and sustainability factors
where these are “financially material”.
Legal Context
1.5

1.6

1.7

This Annex should be read in the lightof the constitutional framework thatapplies in South Africa. South Africa isa constitutional democracy, subject tothe doctrine of constitutional supremacy
in that the Constitution1 is the supremelaw, law or conduct inconsistent with theConstitution is invalid, and the obligations
imposed by it must be fulfilled.
The Constitution includes a Bill of Rights
comprising various justiciable politicaland social and economic rights that
apply in South Africa both vertically(from the state to its citizens) andhorizontally (between one natural or
juristic person and another).2 For example,
the environmental right provides,
among other things, that “Everyone
has the right to have the environment
protected, for the benefit of present andfuture generations, through reasonablelegislative and other measures that secure
ecologically sustainable development
and use of natural resources while
promoting justifiable economic and social
development.” A number of the rights in
the Bill of Rights concern matters – suchas education, housing and health – thatalign with sustainability goals and would
benefit from IFSI.
As regards possible future developmentof the law, the Constitution places anobligation on the courts, when applying aprovision of the Bill of Rights to a natural
or juristic person to apply or, if necessary,

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION

develop the common law to the extent thatexisting legislation does not give effect toa right.3 Additionally, when interpreting
the Bill of Rights, a court, tribunal orforum must consider international law(for example, in respect of climate change
and sustainable development), and may
consider foreign law.4
1.8

1.9

1.10

410

Within this constitutional framework,
the overarching legislation relevant to
the financial sector is the Financial Sector
Regulation Act, 2017 (FSRA). It came into
operation on 1 April 2018 and introduceda ‘twin peaks’ model of financial sector
regulation in South Africa in that it
established two regulators: the Prudential
Authority, within the South African
Reserve Bank, tasked with prudential
regulation; and the Financial Sector
Conduct Authority (FSCA), tasked withmarket conduct regulation.
The FSRA’s main object is to achieve astable financial system that works in
the interests of financial customers andthat supports balanced and sustainableeconomic growth in South Africa.5 It
includes a broad compliance obligation
whereby, if a financial sector law imposes
an obligation to be complied with by anentity that is a juristic person/legal entity,
such as an Asset Owner or an Investment
Manager, the members of the governing
body6 of that juristic person must ensurethat the obligation is complied with.7
The Prudential Authority is responsible
for, among other things, the prudential
regulation of insurers. The FSCA’s
functions include regulating andsupervising the conduct of various
financial institutions (particularly in
relation to the provision of financial
services), including: pension funds,

insurers and collective investment
schemes (CISs), (the most prevalent typeof regulated mutual fund in South Africa),
in accordance with applicable “financial
sector laws”, including: the Pension Funds
Act, 1956; the Long-term Insurance Act,
1998; the Short-term Insurance Act, 1998;
the Financial Advisory and Intermediary
Services Act, 2002; the Collective
Investment Schemes Control Act, 2002;
the Financial Markets Act, 2012; and theInsurance Act, 2017.8
1.11

In order to achieve their respective
objectives, the Prudential Authority
and the FSCA are empowered to makeprudential standards9 and conduct
standards10 respectively, or joint standards,
in respect of financial institutions. Thesestandards relate to various matters
including the governance of financial
institutions, the duties and responsibilitiesof members of governing bodies andtheir substructures, and the operationof financial institutions, including
investment activities – and therefore
have a bearing on IFSI. Industry-specificguidance from regulators is relevant toinvestment-related decision-making. Andin carrying out regulatory enforcement
action, a regulator will look to establish
whether such guidance has been followed.

1.11.1 Also informing investment activities anddecision-making is a body of common law,or so called “judge-made” law, relevant
to fiduciary duties, and the exercise of
powers by fiduciaries and trustees, among
other matters.
Sustainable Finance Initiative
1.12

Globally, the legal and policy landscape
relevant to IFSI is changing rapidly, andSouth Africa is no exception. In 2017,
National Treasury convened a Working

Group of financial sector regulatory
agencies and industry associations
to develop a framework document
on sustainable finance.11 Following
stakeholder engagements, National
Treasury in May 2020 published a Draft
Technical Paper on Financing a Sustainable
Economy (Sustainable Finance Paper).12
1.12.1 The objectives of the Sustainable Finance
Paper include:(a) defining sustainable finance for all partsof the South African financial sector
including: banking, retirement funds,
insurance, asset management and capital
markets;(b) taking stock of the global and national
financial sector policy, regulatory andindustry actions taken to date in dealing
with environmental and social (E&S) risks
and opportunities;(c) identifying market barriers to sustainablefinance and the implementation of E&S
risk management best practices;(d) identifying gaps in the existing regulatory
framework and recommending actions
required of regulators, financial
institutions and industry associations;(e) enhancing financial stability through better
understanding of E&S factors, including theconcept of a just transition; and(f) making recommendations for implementing
sustainable finance in South Africa throughregulatory and industry actions. These
encompass general recommendations
applicable to all financial services andindustries, and recommendations specific tocertain sectors.
These objectives stem from a recognition“that there is a need for greater policy
coherence for the [financial] sector,
regulatory guidance and oversight. There

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION

is also real urgency to rapidly increase
local financial sector capability to respondto the prevailing social and environmental
challenges, which will increasingly have amajor impact on our economic resilienceand national well-being”.13
1.12.2 The Sustainable Finance Paper makes
recommendations for a process to establish
minimum practice and standards withregard to climate change and emerging
environmental and social risks. It
recommends the adoption of the following
definition of “sustainable finance”:“Sustainable finance encompasses
financial models, products, markets andethical practices to deliver resilience andlong-term value in each of the economic,
environmental and social aspects andthereby contributing to the delivery of thesustainable development goals and climate
resilience. This is achieved by the financial
sector by:(a) evaluating portfolio as well astransaction-level environmental andsocial risk exposure and opportunities,
using science-based methodologies andbest practice norms;(b) linking these to products, activities andcapital allocations;(c) maximising opportunities to mitigate risk
and achieve benefits in each of the social,environmental and economic aspects; and(d) contributing to the delivery of thesustainable development goals.”14This proposed definition of “sustainablefinance” informs proposed revisions to theCode for Responsible Investing in South
Africa (CRISA), described at paragraph1.14 onwards below.
1.12.3 Insofar as IFSI is concerned, the Sustainable
Finance Paper briefly touches on “impact
411

investment” as a sector innovation insustainable finance, which it describes
as “investments made into companies,
organisations and funds with the intention
to generate positive E&S impact alongside
a financial return”.15 It goes on to notethat and suggests that “Impact investing ison the radar of the South African private
equity sector but appears to be mostly
funded by big corporates looking to build
their B-BBEE supply chains and enterprisedevelopment corporate social investment
initiatives, where a financial return is notalways expected.”16
1.12.4 Both instrumental IFSI and ultimate ends
IFSI are consistent with the objectives andproposed definition of sustainable financeset out above. While we believe the current
legal and regulatory framework in South
Africa permits IFSI, subject to limitations
and constraints described in Section 2
below, there is certainly scope for legal
and regulatory action to encourage andfacilitate IFSI in South Africa.
1.12.5 In June 2021, pursuant to the Sustainable
Finance Paper’s recommendation to“develop or adopt a taxonomy for green,social and sustainable finance initiatives,
consistent with international developments,
to build credibility, foster investment andenable effective monitoring and disclosureof performance”, a working group chaired
by National Treasury published a Draft
Green Finance Taxonomy.17
The Code for Responsible Investing in South Africa(CRISA)
1.13

Published in 2011, CRISA18 is a voluntarycode that applies to both institutional
investors (for example, pension funds,
insurers and CISs discussed in this Annex)
and their service providers (asset managers,
fund managers and consultants).19

1.14

CRISA provides guidance on how
institutional investors should execute
investment analysis and investment
activities and exercise their rights so
as to promote responsible investment
and sound governance. It comprises a
set of five “apply or explain” principles,
which are similar to those of the UN
PRI. Institutional investors demonstrate
their endorsement of CRISA by applying
the CRISA principles, and by publishingannual reports and disclosures on theirapplication of CRISA.20

1.14.1 Principle 1 of CRISA recommends that
institutional investors should incorporate
sustainability considerations, including
ESG, into investment activities as “partof the delivery of superior risk-adjusted
returns” to Beneficiaries. The principles
do not refer to the achievement of positive
Sustainability Impact as a goal in itself.
1.14.2 Additionally, CRISA recommends that an
institutional investor should:(a) Principle 2: Demonstrate its acceptance ofownership responsibilities in its investment
arrangements and investment activities;(b) Principle 3: Where appropriate,
consider a collaborative approach topromote acceptance and implementationof the principles of CRISA and othercodes and standards applicable toinstitutional investors;(c) Principle 4: Recognise the circumstancesand relationships that hold a potential for
conflicts of interest and should proactively
manage these when they occur; and(d) Principle 5: Be transparent about thecontent of its policies, how the policies
are implemented and how CRISA isapplied to enable stakeholders to makeinformed assessments.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION

1.15

The CRISA Committee – recognising“a growing consensus that investment
needs to be aligned with the direction ofchange, [and] seeking out opportunities
to influence and contribute to theenvironment and society throughinvestment arrangements and activities
that target an economy which is bothgreen and inclusive”, and that “further
innovations … are needed to achieve asystemic shift from commitment into
action with more impact” – has recently
initiated a project to develop a revised
CRISA Code, a draft of which it published
for public comment in November 2020.21

1.15.1 It is proposed that the revised CRISA will
and can be applied on a proportionate
basis by investors, using an “apply andexplain” regime (rather than the current“apply or explain” regime).
1.15.2 The draft revised CRISA comprises ofthe following principles, each of which
represents ideal states of being or
operation at an institutional investor:(a) Principle 1: Integration of sustainablefinance. Investment arrangements andactivities reflect a systematic approach
to integration of sustainable financepractices, including the identificationand consideration of materially relevant
ESG and broader sustainable development
considerations;(b) Principle 2: Diligently discharging
stewardship duties. Investment
arrangements and activities demonstrate
the acceptance of ownership
responsibilities (where applicable) andenable diligent discharge of stewardshipduties through purposeful engagement
and voting;(c) Principle 3: Capacity building andcollaboration. A collaborative approach412

is taken where appropriate to promote
acceptance and implementation of theprinciples of CRISA and other relevant
codes and standards, to support thebuilding of capacity throughout theinvestment industry and enhance soundgovernance practices;(d) Principle 4: Governance. Sound
governance structures and processes
are in place to enable oversight ofand accountability for investment
arrangements and activities towards
diligent stewardship and responsible
investment, including proactively
managing conflicts of interest; and(e) Principle 5: Transparency. Meaningfuldisclosure is made at set time intervals
in relation to the investment
arrangements and activities across asset
classes that support the integration ofsustainable finance practices,discharging of stewardship duties andcollaborative initiatives.
1.15.3 Under each principle the revised CRISA
sets out practice recommendations
focusing on implementation and reporting
to support action and transparency.
Although not legally binding, the revised
draft CRISA is significant in that it adopts
an outcomes-based approach that will:

which it means “managing investment
arrangements and activities towards
the creation of long-term value for the
economy, the environment and society
as part of the delivery of superiorrisk-adjusted returns to clients andbeneficiaries”; and(d) contribute to the disclosure andtransparency of endorsers’ investment
activities, stewardship and collaboration
initiatives, thereby contributing
to beneficiaries and stakeholders’information, oversight and expectations.
King IV
1.16

1.17(a) provide guidance designed to promote
good and responsible investment practices
among institutional investors;(b) through its practice recommendations set
and inform market practice standards,
which standards regulators may take into
account in considering applicable rules
and duties, and in exercising oversight ofAsset Owners or Asset Managers;(c) more explicitly encourage the diligent
discharge of stewardship duties, by

1.18

The King Codes prepared by the Instituteof Directors of Southern Africa, of
which The King IV Report on Corporate
Governance for South Africa, 2016 (King IV)
is the latest iteration, set out “voluntary
principles and leading/recommended
practices” as guidelines to promote good
corporate governance across all kinds oforganisations in South Africa.22
Many Asset Owners and Investment
Managers subscribe to King IV and take itinto account in their governance. Insurers
and public companies whose sharesare listed on the Johannesburg Stock
Exchange are obliged by the JSE Listings
Requirements to apply King IV, and toreport on their application of King IV
principles and recommendations in theirannual integrated reports.
King IV sets out various principles thatan organisation either should apply inorder to substantiate a claim that it ispractising good governance, reflectedin four outcomes: ethical culture, good
performance, effective control andlegitimacy. It asserts that these outcomesmay be achieved by careful consideration
and application of the recommended

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B. THE EXTENT TO WHICH
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Netherlands
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REFERENCES

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practices that underpin the principles.
1.19

1.20

1.21

413

King IV adopts an “apply and explain”
regime, i.e. apply the principles andexplain that application with reference
to the practices demonstrating suchapplication. This is intended to generate
an account that allows stakeholders,
including shareholders, to evaluate andindependently assess the extent to which
the company or group is applying theprinciples and recommendations in King
IV. The recommended practices ought
to be applied proportionally in line withthe organisation’s size and resources,and extent and complexity of theorganisation’s activities.
Sustainable development is an overarching
concept that informs the principles andrecommendations of King IV. King IV
regards sustainability as an element of
the value creation process relevant toall organisations, whilst emphasisingsustainable development as “a primary
ethical and economic imperative” and “afitting response to the organisation being
an integral part of society, its status asa corporate citizen and its stakeholders’needs interests and expectations. The
survival and success of organisations areintertwined with, and related to, threeinterdependent subsystems: the triple
context of the economy, society and thenatural environment”. King IV is informedby trends towards more sustainable
capital markets and the need to create
value in a sustainable manner over the
longer term.
Additionally, the philosophies
underpinning the approach to good
governance adopted under King IV are
directly and indirectly relevant to IFSI.
The stated philosophies reflect andrecognise three paradigm shifts thatappear to be taking place:(a) First, the shift from financial capitalism toinclusive capitalism, which takes accountof all sources of capital which are involvedin the value-creation process.
(b) Second, that from short-term capital
markets to long-term, sustainable capital
markets, arising from the need to create
value in a sustainable manner, and assess
performance over the longer term.
(c) Third, the shift from silo reporting tointegrated reporting, a process founded on
integrated thinking.
1.22

The following King IV principles are
relevant to IFSI:(a) Principle 17: Responsibilities ofInstitutional Investors. The governing
body of an institutional investor
organisation [such as a pension fund,insurer or CIS] should ensure that
responsible investment is practiced by
the organisation to promote the good
governance and the creation of value by
the companies in which it invests;(b) Principle 4: The governing body should
appreciate that the organisation’s core
purpose, its risks and opportunities,
strategy, business model, performance andsustainable development are all inseparable
elements of the value creation process;(c) Principle 3: The governing body should
ensure that the organisation is and is seen
to be a responsible corporate citizen; and(d) Principle 16: In the execution of its
governance role and responsibilities, thegoverning body should adopt a stakeholderinclusive approach that balances the needs,interests and expectations of material
stakeholders in the best interests of theorganisation over time.

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B. THE EXTENT TO WHICH
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Netherlands
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2.

ASSET OWNERS’ USE OF POWERS OF INVESTMENT AND DIVESTMENT TO INVEST FORSUSTAINABILITY IMPACT

2.1

The following Section considers the extent
to which and in what circumstances, eachtype of Asset Owner is:

terms of the employment of a member
on behalf of beneficiaries, payable on thedeath of more than one member of one ormore pension funds.

(a) required; or(b) permitted, or able, to use its powers ofinvestment and divestment to IFSI.

2.2.3

Pension funds

2.2

Types of pension fund covered
2.2.1

2.2.2

A variety of occupational and otherretirement funds are provided for in South
Africa, the majority of which are regarded
as “pension funds” under the Pension
Funds Act, 1956 (Pension Funds Act).23
The following organisations are regulated
as “pension funds” under the Pension
Funds Act:(a) any association of persons establishedwith the object of providing annuities
or lump sum payments for members
or former members of the association
when they reach retirement, or for the
dependants those members or former
members upon their death; or(b) any business carried on under a schemeor arrangement established with theobject of providing annuities or lumpsum payments for persons who belong or
belonged to the class of persons for whose
benefit that scheme or arrangement
has been established, when they reachretirement or for dependants of those
persons upon their death; or(c) any association of persons or businesscarried on under a scheme orarrangement established with the objectof receiving, administering, investing andpaying benefits that became payable in
414

2.2.4

2.2.5

2.2.6

funds”. An underwritten pension fund’s
only asset is a policy of insurance in termsof which, when a beneficiary becomes
entitled to a retirement or risk benefit interms of the fund’s rules, the insurer must
pay a corresponding, equivalent benefit to
the fund so that it may meet its obligation
to the beneficiary. Underwritten funds
are required to comply with the same
prudential investment regulations asother pension funds, and accordingly
insurers are obliged to develop policies
whose underlying asset allocations andstrategies are compliant with thoseregulations in order for those policies tobe marketable to underwritten funds. The
pension fund’s board will choose from theavailable suite of investment portfolios toalign with the fund’s investment strategy.

Occupational retirement funds are pension
funds to which members belong byvirtue of the terms of their employment,
voluntary retirement funds include
preservation funds (where there is noemployer/employee relationship and thefund is established for preserving benefits
from other approved pension funds ontermination of membership) and retirement
annuity funds (no employer/employee
relationship, and members contributevoluntarily to a fund, with the benefits
becoming accessible at age 55 or later), andare also regulated as pension funds.
Pension funds are special purpose notfor-profit legal entities, through which
members and/or their employers (in thecase of occupational retirement funds)
provide for the payment of benefits on thehappening of certain events (e.g. death,retirement, withdrawal, ill-health) inaccordance with the rules of the fund andthe Pension Funds Act.
Funds are required to be registered under
the Pension Funds Act before commencing
any retirement fund business.24 Upon
registration, a pension fund becomes abody corporate capable of suing25 andbeing sued in its corporate name, of
having assets and liabilities, rights andobligations, and of doing all such things as
may be necessary for or incidental to theexercise of its powers or the performanceof its functions in terms of its rules.26
Many pension funds are “underwritten

2.2.7

2.2.8

Certain retirement funds are not subject
to the Pension Funds Act and have been
established under their own statute.
The largest of these is the Government
Employees Pension Fund (GEPF), withmore than 1.2 million active members,
in excess of 450,000 pensioners andbeneficiaries, and assets of over R1.6
trillion. The GEPF is a defined benefit
pension fund. The fund operates under
the Government Employee Pension Law
and Rules, which prescribes how the GEPF
is to be governed, and how pension andrelated benefits of members, pensioners
and beneficiaries are to be administered.
In discussing pension funds in thismemorandum, we use the following
expressions in the way described:

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GLOSSARY
REFERENCES• Asset Owner: Pension funds, being legal

entities, are the owners of the assets that
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they hold in the best interests of
their members;

The GEPF’s investment manager is the
Public Investment Corporation SOC
Limited (PIC), a state-owned corporation
and registered financial services provider(FSP), which has the Minister of Finance as
its shareholder representative.

• Beneficiaries: A pension fund’s

beneficiaries are its members and include
those who belong or belonged to a classof persons for whose benefit that fundhas been established, either by virtueof the terms of their employment or
by voluntary association. Beneficiaries
of funds also include a dependant ofa member who is entitled to a benefit
in terms of the rules of the fund (i.e. a
spouse, a child or any other person who
was found to be dependent on a member
prior to his or her death); and

2.3

2.3.1

fund has a board consisting of at least
four board members who are tasked withdirecting, controlling and overseeing
the operations of the fund, including
investment strategy, in accordance with theapplicable laws and the rules of the fund.
The board of the fund consists of various
sub-committees, including and investment
subcommittee who is tasked to deal withthe fund’s investment and its investment
strategy. The investment sub-committee istypically assisted by an Investment Manager
appointed by the fund to assist the board incarrying out its duties.

415

Analysis
2.3.3

Summary conclusion• Investment decision maker: Every pension

Underwritten retirement funds only
maintain an insurance policy, while theinsurer owns the underlying assets under
its policy, and accordingly it is the insurer’s
investment management arrangements that
determine the investment of the underlying
portfolios, in accordance with the regulations
applicable to insurance companies (although
the product must comply with the regulatory
requirements for pension funds in order for
it to be marketable).

Overview of investment duties andpowers, and use of investment powers to
Invest for Sustainability Impact

board takes all reasonable steps to ensurethat the interests of the fund’s members
are protected in terms of the fund’srules and the Pension Funds Act. This
would mean that the financial return andSustainability Impact goals would have tobe pursued in parallel.

2.3.2

Pension funds are legally required topursue instrumental IFSI (i.e. IFSI as anintermediate goal to achieve a financial
return), but not ultimate ends IFSI (i.e. asa goal in itself in parallel with financial
return). A pension fund could be legallyrequired to pursue ultimate ends IFSI
where it, or a particular investment
portfolio within it, is established withthat express, recorded mandate. The
requirement for a pension fund, under
Regulation 28 of the Pension Funds Act
to give appropriate consideration to any
factor which may materially affect thesustainable long-term performance of
its assets, including ESG factors, before
investing in and while invested in any
asset, obliges the board to pursue an
instrumental IFSI investment process.
However, it does not go so far as torequire a fund or its board to exercise its
powers to achieve particular prescribed or
described IFSI outcomes.
It is permissible for a pension fundto pursue instrumental IFSI. And it ispermissible for a pension fund to havean objective for a portfolio that would
involve ultimate ends IFSI (in addition tohaving an investment objective to achievea particular investment return) subject tothe board’s duty to ensure that the fundis on the whole finically sound and its

2.3.4

The board of a pension/retirement fundis tasked with directing, controlling andoverseeing the operations of the fund inaccordance with applicable laws and therules of the fund, its principal, and is the
directing mind and will of the fund.
The board:(a) must take all reasonable steps to ensurethat the interests of members in terms of
the rules of the fund and the provisions of
the Pension Funds Act are protected at all
times. These interests would be primarily
in the receipt of adequate benefits inretirement or upon the occurrence of therelevant defined event, in accordance withthe terms of the policy;(b) must act with due care, diligence andgood faith;(c) must avoid conflicts of interest;(d) must act with impartiality in respect of all
members and beneficiaries;

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Netherlands(e) must act independently;

South Africa(f) has a fiduciary duty to members andbeneficiaries in respect of accrued benefits
or any amount accrued to provide abenefit; andUnited Kingdom(g) has a fiduciary duty to the fund (itsprincipal), to ensure that the fund isfinancially sound, responsibly managed,
and governed in accordance with thefund’s rules, the Pension Funds Act andapplicable laws. The FSCA has published

United States

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REFERENCES

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a notice which sets out a minimum basis
on which the financial position of a fundshould be evaluated and calculated todetermine whether or not it is financiallysound. How and if a fund will remain
financially sound depends on, amongst
other things, the investment of the fund’s
assets to meet its liabilities.27
2.3.5

It is worth noting that:(a) the board has a fiduciary duty in respectof the fund’s long-term interests which
may on occasion override the interests ofindividual members and stakeholders of
the fund;(b) the separate but narrower statutory
fiduciary duty that the board owes tomembers and beneficiaries pertains only
to accrued benefits (in effect, amounts
held in trust for specific beneficiaries) or
any amounts accrued to provide a benefit(which may be attributable to individual
members or beneficiaries, or identifiablegroups, for example, pending transfer ofmembership to another pension fund); and(c) the board does not have a general
fiduciary duty in relation to its members
and beneficiaries, rather it is obliged
to take reasonable steps to ensure that
their interests as set out in the Pension
Funds Act and the rules of the fund areprotected.
2.3.6

416

2.3.7

Further duties of the board include
ensuring that adequate and appropriate
information is communicated to themembers and beneficiaries of the fundinforming them of their rights, benefits
and duties in terms of the rules of thefund, and that the rules and the operation
and administration of the fund comply
with the Pension Funds Act, the Financial
Institutions (Protection of Funds) Act, andall other applicable laws.28

2.3.8

2.3.9

A retirement fund’s object is ordinarily
to pay benefits to its members and otherbeneficiaries (current and future) in termsof its rules. Different benefits are payable
upon the happening of different events,
such as withdrawal, death and retirement.
To achieve its object, the principal duty ofthe board of a fund is to ensure that thefund is and will remain financially soundthroughout the lifetime of the fund.

2.3.10 Insofar as investment powers areconcerned, retirement funds generally
have broad investment powers, provided
that such powers are exercised inaccordance with applicable laws, the rulesof the fund and the fund’s investment
policy statement (IPS).

The powers of the board are derived fromand limited by legislation and the fund’srules. The rules of a fund describe thepurpose and business of the fund, thetype of fund, the objects of the fund, therights and obligations of the members andemployers (if any) participating in the fund,and establish the powers of the board oftrustees of the pension fund. Investment
duties and powers may therefore be shapedby the rules of the fund.

(a) describes a fund’s general investment
philosophy and objectives, as determinedby its liability profile and risk appetite;

Subject to the provisions of the Pension
Funds Act, the rules of a registered fundare binding on the fund and its members,
officers, and on any person who claims
under the rules or whose claim is derived
from a person so claiming.29 As theSupreme Court of Appeal put it: “Thetrustees of a fund are bound to observeand implement the rules of that fund.
Their powers and responsibilities and therights and obligations of members andparticipating employers are governed by
the rules, applicable legislation and thecommon law. The rules of a fund form its
constitution and must be interpreted in
the same way as all documents.”30 And:
“What the trustees may do with the fund’s
assets is set forth in the rules. If what they
propose to do (or have been ordered to do)
is not within the powers conferred uponthem by the rules, they may not do it.”31

2.3.11 The board is required to prepare an IPS
under Regulation 28 of the Pension Funds
Act. The IPS:(b) must be appropriate and adequate forits liabilities. There is no duty on theboard or fund to pursue maximum
return on investments at all costs; its
object is to ensure that the fund is andremains financially sound. Regulation 28
contemplates “adequate”, “appropriate”,“responsible” investment of a fund’s
assets. The trustees “mandate” isdescriptive rather than prescriptive;(c) addresses principles with which aretirement fund and the board must at all
times comply,32 including:
(i)

(ii)

understanding the changing risk
profile of assets of the fund over time,taking into account comprehensive risk
analysis, including but not limited tocredit, market, liquidity and operationalrisk, and currency, geographic andsovereign risk of foreign assets; andbefore investing in and whilst invested
in an asset consider any factor which
may materially affect the sustainablelong-term performance of the asset
including, but not limited to, thoseof an environmental, social andgovernance character (ESG factors);33 and

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REFERENCES(d) must be reviewed annually.
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2.3.12 Regulation 28 also regulates a fund’s
assets spreading requirements. Amongother things, it stipulates that a fund must
only hold assets and categories of assets
referred to in Table 1 to the Regulationand must comply with the limits set out
in Regulation 28.
2.3.13 Regulation 28 promotes responsible
investing of fund assets, based onsustainable, long-term, risk aligned andliability driven investment philosophy.
Its preamble sets out the expectations on
funds when investing their assets:“A fund has a fiduciary duty to act in thebest interest of its members whose benefits
depend on the responsible managementof fund assets. This duty supports the
adoption of a responsible investment
approach to deploying capital into
markets that will earn adequate risk
adjusted returns suitable for the fund’s
specific member profile, liquidity needs
and liabilities. Prudent investing should
give appropriate consideration to any factor
which may materially affect the sustainablelong-term performance of a fund’s assets,
including factors of an environmental, socialand governance character. This concept
applies across all assets and categories ofassets and should promote the interestsof a fund in a stable and transparent
environment.” (Emphasis added.)
2.3.14 The suggestion in the preamble above thata fund (through its board) has a blanket
fiduciary duty to act in the best interestsof members, seems to be inconsistent
with the narrower fiduciary duty on theboard in the Pension Funds Act mentioned
above: a fiduciary duty to members andbeneficiaries in respect of accrued benefits
or any amount accrued to provide a417

benefit. Although the preamble is notlegally prescriptive, to the extent that aprovision prescribed in the Regulation isinconsistent with a statute the provisionsof the statute, in this case, the Pension
Funds Act, the provisions of statute would
prevail. Further, the fund (through its
board) is not obliged to act in the bestinterests of its members, it is obliged totake their interests into account.
2.3.15 The principles with which a retirement
fund must comply under Regulation 28(2)(c) include:(a) in contracting services to the fundor its board, consider the need topromote broad-based black economic
empowerment (B-BBEE) of those
providing services;34(b) before making a contractual commitment
to invest in a third party managed asset orinvesting in an asset, perform reasonable
due diligence taking into account risks
relevant to the investment including, but
not limited to, credit, market and liquidity
risks, as well as operational risk for assets
not listed on an exchange;(c) in performing due diligence a fund may
take credit ratings into account, but suchcredit ratings should not be relied on in
isolation for risk assessment or analysis ofan asset and should not be to the exclusionof a fund’s own due diligence; and(d) understand the changing risk profile ofassets of the fund over time, taking into
account comprehensive risk analysis,
including but not limited to: credit,
market, liquidity and operational risk, andcurrency, geographic and sovereign risk offoreign assets.
2.3.16 Neither the Pension Funds Act, nor
Regulation 28, defines the concepts“materially”, “sustainable” or “sustainablelong-term performance”. Guidance Notice
1 of 2019 (Guidance Notice 1), which is not
hard law but FSCA guidance on Regulation
28 defines “sustainability” as: “the abilityof an entity to conduct its business in amanner that primarily meets existingneeds without compromising the abilityof future generations to meet their needs.
Conducting business sustainably includes
managing the interaction of the businesswith the environment, the society andthe economy in which it operates towards
a better long-term outcome. Evaluating
the sustainability of the business of anentity includes the consideration of
economic factors and ESG factors. The“sustainability of an asset” implies thesustainability of the entity giving rise to
the underlying value of the asset.”
2.3.17 The reference to “any factor” which may
materially affect the sustainable long-term
performance of a fund’s asset in Regulation
28 and the guidance above suggests thatboth traditional economic factors (suchas credit, market and liquidity risks) and
ESG factors should be taken into accountwhere they may materially affect the longterm financial performance of an asset.
Guidance Notice 1 defines “ESG factors”
as “environmental, social and governancefactors. In the South African context, andspecifically in respect of assets located inSouth Africa, these factors include, but
are not limited to, the manner in which[B-BBEE] is advanced”.
2.3.18 Guidance Notice 1 also describes thesustainability of investments and assets
in the context of a fund’s IPS, and notesthat the sustainability of a fund’s assets
is a key factor that should inform its IPS.
To this end, Guidance Notice 1 says that

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION“where a fund holds assets that limit theapplication of ESG factors, sustainability
criteria or the full application of active
ownership policy, the IPS should also
state the reasons as to why this limitation
is to the advantage of both the pension
fund and its membership”. Moreover,where the IPS does not state the reasonsfor the limitation described above,
Guidance Notice 1 says it should “set out
the remedial action the fund has taken
or intends taking to rectify the position.
Where no remedial action is being
considered or taken, the fund should set
out the reasons therefor.”2.3.19 While South Africa’s retirement fundindustry has for many years been legallyrequired to consider material ESG factors
in their investments, it is clear that they
are now being asked to increase thetransparency of their ESG disclosure andreporting. It remains to be seen how funds
and members respond to Guidance Notice
1, and what the FSCA will do if funds
do not meet its expectations set out inGuidance Notice 1.
2.3.20 Regulation 28 should not be interpreted
in isolation of the fund’s object. Where
the object of a retirement fund is toprovide benefits to members and theirbeneficiaries in terms of the rules ofthe fund, then the primary duty of theboard of that fund is to ensure that thefund remains financially sound to fulfil
its obligations to the members and theirbeneficiaries in terms of the rules.
2.3.21 Separately, the GEPF is required in termsof its governing statute, the Government
Employees Pension Law, 1996 (GEP Law),
to determine the investment policy of
the fund in consultation with the Ministerof Finance.35
418

2.3.22 The GEPF’s core business is to manage
and administer pensions and related
benefits for government employees inSouth Africa. The GEPF’s assets include
money contributed by and on behalfof State employees, and they belong to
the GEPF and are invested in the nameof the GEPF and for its account. The
executive authority of the GEPF is theBoard of Trustees, which is responsible
for both administrative and investment
performance of the fund.
2.3.23 The duties and powers of the GEPF
Board are prescribed by the GEP Law
and Rules,36 which require, among otherthings, that investments are made andmaintained in accordance with the GEPF’s
investment strategy.
2.3.24 The GEPF has adopted an IPS, theobjectives of which include:(a) to apply a responsible investment
approach by ensuring the integration of
ESG factors into investment processes,
so as to better manage risk and generate
sustainable, long-term returns; and(b) to contribute to B-BBEE (described aboveat footnote 33) and the transformationof the South African economy and its
investment industry.37 The investment
policy can be changed by the GEPF
board, provided that any change in theinvestment policy which may affect theGovernment’s financial obligation towards
the GEPF, shall be subject to the approvalof the Minister of Finance.
Legal requirements to use investment powers to
Invest for Sustainability Impact
2.3.25 Although the concept of being obliged topursue a goal other than financial returnis not totally unknown (for example,
contributing to B-BBEE or transitioning

away from carbon intensive investments),
looking specifically at pension fundinvestment powers:(a) a pension fund is not legally required
to have an objective for a portfolio thatwould involve IFSI, rather than or in
addition to having an investment objective
to achieve a return that enables a fund tomeet its obligations towards its members
or beneficiaries; and(b) the board and trustees are not generally
subject to a duty to exercise investment
powers to achieve positive Sustainability
Impact but are required to pursue an
instrumental IFSI approach.
2.3.26 This would not prevent a pension
fund board from selecting investment
options on the basis of the anticipatedfinancial return which effectively involve
instrumental IFSI, for example, should
they decide to invest in traditional impact
investment funds in the interests ofportfolio diversification.
2.3.27 Where a pension fund board concludes
that sustainability factors present asystemic risk which could prevent it fromensuring that the fund is financially soundover the long-term, the board might decidethat it should engage in one or more
instrumental IFSI activities, ranging fromdisinvestment to stewardship with investee
enterprises designed to avert that risk inorder to discharge its duties (see further
paragraph 3.1.5 below). In that context, it
might also conclude from time-to-time thatit should under or overweight a particularinvestee company in order to strengthen its
voice as part of those activities.

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United States

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Legal freedom to use investment powers to Invest for
Sustainability Impact
2.3.28 The duties and powers as discussed
above appear to be sufficiently flexible
for a pension fund to have an objective
for a portfolio that would involve
ultimate ends IFSI (in addition to having
an investment objective to achieve aparticular investment return) subject tothe board’s duty to ensure that the fundis on the whole finically sound and its
board takes all reasonable steps to ensurethat the interests of the fund’s members
are protected in terms of the fund’srules and the Pension Funds Act. This
would mean that the financial return andSustainability Impact goals would have tobe pursued in parallel. Depending on thefact-specific circumstances, this flexibility
may include scope for more selective overweighting or under-weighting investments
in individual issuers from time-to-time inorder to strengthen stewardship activities
and scope to select individual investments
for the portfolio based on the desire
to achieve a Sustainability Impact inrelation to the relevant enterprise as wellas the requisite financial return (on theassumption that this can be done in a waythat does not detract from maintaining
the financial soundness of the portfolio
and taking all reasonable steps to ensurethat the interests of the fund’s members
are protected in terms of the fund’s rules
and the Pension Funds Act).
2.3.29 If, based on information available to afund’s board at the time of making (andreviewing) investment decisions thattarget Sustainability Impact, there appears
to be a reasonable prospect of sufficiently
positive long-term financial outcomes,
then the decision making process is sound419

and legally defensible, and is likely towithstand scrutiny even if the investment
outcomes are poorer than anticipated,even adverse (financially or otherwise).
2.3.30 While Beneficiaries’ views or a wider
measure of Beneficiary welfare than solely
financial welfare may be relevant to apension fund board’s decision to conduct
ultimate ends IFSI on the bases set out
above, there is no legal requirement toascertain Beneficiaries’ views on IFSI,
or for their views to inform an IPS.
Guidance Notice 1 “encourages” pension
funds, in the interest of transparency,
accountability and fair treatment of its
members, to:(a) make their IPSs available on request toeach member and each participating
employer, and available on their website
so that it is accessible to any person; and(b) at least annually, provide a copy or informstakeholders that the IPS and any changes
thereto are available on its website.

CISs include unit trusts, exchange tradedfunds, hedge funds, and open-ended
investment companies.39
2.4.2(a) CIS in securities, where the portfolio
consists mainly of securities;(b) CIS in property, which includes property
shares and immovable property;(c) CIS in participation bonds; and(d) hedge funds, funds which use any strategy
or take any position which could resultin the funds incurring losses greater thantheir aggregate market value at any point
in time, and which strategies or positions
include but are not limited to leverage; ornet short positions.
2.4.3

Mutual funds

2.4

Types of mutual fund covered
2.4.1

A CIS is a scheme, in whatever form, in
pursuit of which members of the public
are invited or permitted to invest moneyor other assets in a portfolio, and in termsof which:(a) two or more investors contribute money
and hold a participatory interest in a
portfolio of the scheme through shares,
units or any other form of participatoryinterest; and(b) the investors share the risk and thebenefit of investment in proportion totheir participatory interest in a portfolioof a scheme, or on any other basis
determined in the deed of the scheme.38

The establishment and administrationof CISs is primarily regulated by theCollective Investment Schemes Control
Act, 2002 (CISCA). CISs regulated under
CISCA are:

2.4.4

CISCA also provides for a “declared
collective investment scheme”, which is a
CIS other than a CIS in securities, property
or participation bonds, declared by the
FSCA to be a CIS.40 Hedge funds were
declared a CIS in terms of this provision.
Additionally, a manager or operator ofa foreign CIS may apply to the FSCA for
approval to solicit investments in theforeign CIS from members of the public in
South Africa.41
In discussing CISs in this memorandum,
we use the following expressions in theway described:(a) Asset Owner: A CIS is the legal ownerof the underlying assets of eachportfolio.42However, it is the authorised
CIS manager that is responsible for dayto-day administration of the fund andmaking investment decisions;

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION(b) Beneficiaries: A CIS’s beneficiaries are
its current investors, who hold beneficial
ownership of the underlying assets of eachportfolio; andresponsible manner, and maintainadequate financial resources to meet its
commitments and manage the risks towhich the CIS is exposed;44(c) Investment decision-maker: In terms of
CISCA, the investment decision-makeris the manager authorised by the FSCA
to administer the CIS. Authorised CIS
managers usually delegate investment
decision-making powers to their own
Investment Managers but will retain
responsibility for the Investment
Manager’s decisions.

(c) administer a CIS honestly and fairly, withskill, care and diligence;

Overview of investment duties andpowers, and use of investment powers
to IFSI
Summary conclusion
2.4.5

Given that CIS’ investment and a CIS
manager’s investment duties and powers
are driven by the CIS’ investment policy/
objectives, it is unlikely that the CIS
manager would be required to use its
investment powers to pursue instrumental
IFSI where the investment policy andobjectives of the CIS do not provide for
IFSI. Where the investment policy andobjectives of the CIS provide for IFSI, the
CIS manager would be legally required or
permitted to use its investment powers
to ultimate ends IFSI. There is scope fora CIS manager to engage in instrumental
IFSI and ultimate ends IFSI stewardshipand public policy work, subject to any
limitations inherent in the CIS’ deed andinvestment policy/objectives.

Analysis
2.4.6

The investment of money or other assets43
in respect of a CIS, is primarily regulated
by CISCA.

(a) A CIS manager must:(b) organise and control the CIS in a
420(d) administer a CIS in the interest ofinvestors, being the Beneficiaries who
hold participatory interests in a CIS,
and the collective investment scheme
industry;45 andcalculated to gain, directly or
indirectly, any improper advantage
for any person to the prejudice ofthe financial institution or principal
concerned;47 and(b) a manager, its authorised agent, trustee
or custodian must deal with such assets
in terms of CISCA and the deed of the CIS,
and in the best interests of investors.
2.4.8(e) appoint, depending on the structure of
the CIS, a trustee or custodian, which
has various duties relating to the CIS
assets, its administration, and overseeing
compliance with CISCA.
2.4.7

For the purposes of CISCA:(a) any moneys or assets received from an
investor are, and an asset of a portfolio
is, regarded as being trust property forthe purposes of the Financial Institutions(Protection of Funds) Act, 2001 (FIA).
Under the FIA, a financial institution or
nominee company46 that invests, holds,
controls, administers or alienates any
funds of a financial institution or any
trust property:(i)must observe the utmost goodfaith and exercise proper care anddiligence with regard to such funds;(ii) must, with regard to the trust
property and the terms of the trust
deed, observe the utmost good faithand exercise the care and diligencerequired of a trustee in the exercise
or discharge of his/her powers andduties; and(iii) may not alienate, invest, pledge,
hypothecate or otherwise encumber
or use the funds or trust property or
furnish any guarantee in a manner

2.4.9

Investment duties and powers may also
be shaped by the deed of the CIS. CISCA
prescribes that the requirements for theadministration of a portfolio must be set
out in a “deed”: an agreement between amanager and a trustee or custodian, or the
document of incorporation that regulates
establishment, administration andmanagement of the CIS.48 A deed must
contain provisions to regulate various
matters specified in CISCA, including
the investment policy to be followed in
respect of each portfolio.
The investment activities of a CIS will
be limited to some extent by the natureof the CIS. The FSCA may determine themanner in which, and the limits andconditions subject to which, a particularasset type may be included in the portfolioof a CIS.49 Additionally, the FSCA has
published Board Notices that apply todifferent types of CIS, which set the limits
and conditions subject to which securities
or classes of securities may be included ina sub-fund or portfolio of a CIS.50

Legal requirements to use investment powers to
Invest for Sustainability Impact
2.4.10 Generally, a CIS is not subject to a duty
to instrumental IFSI rather than, or in
addition to having an objective to achievea particular investment return. This isbecause the manager’s investment powers
must be exercised in accordance with the

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
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investment policy set out in the CIS deed,
which (in the absence of an IFSI object, as
to which see Section [5] below) are likely
to be driven by a financial return, often
by reference to a particular market or
benchmark. Therefore, the motivation
to invest or divest in an individual entity
is likely to need to be the anticipatedfinancial return on that investment, andthe decision must be consistent with the
CIS’s investment policy.
2.4.11 This would not prevent a CIS manager
from selecting investment options on thebasis of the anticipated financial return
which effectively involve instrumental
IFSI. As an example, if a CIS’ investment
policy broadly permits a CIS manager toinvest in shares, the CIS manager could
invest in an entity seeking equity capitalto advance a Sustainability Impact related
project, taking into account its duties
outlined in paragraphs 2.3.7 and 2.3.8
above.
Legal freedom to use investment powers to Invest for
Sustainability Impact
2.4.12 CISs are required to have explicit
investment objectives, including
investment objectives for each sub-fundor portfolio and to disclose such objectives
to prospective Beneficiaries prior to theirinvesting in the CIS. If Sustainability
Impact is not included among thedisclosed investment objectives, a CIS
cannot pursue ultimate ends IFSI, but its
duties outlined in paragraphs 2.3.7 and2.3.8 above may require an instrumental
IFSI approach in relevant circumstances(management of Sustainable Impact
related risk).

421

Overview of investment duties and powers, and use ofinvestment powers to Invest for Sustainability Impact

ACKNOWLEDGEMENTS

Types of insurance undertaking covered
2.5.1

Summary conclusions

EXECUTIVE SUMMARY

2.5

2.5.2

2.5.3

Insurance undertakings
Insurers are persons registered to conduct
insurance business – life insurance,
non-life insurance, microinsurance,and reinsurance – under the Short-term
Insurance Act, 1998 (STIA) or Long-term
Insurance Act, 1998 (LTIA), or licensed
to conduct insurance business in South
Africa under the Insurance Act, 2017
(Insurance Act).
The Insurance Act serves as umbrella
legislation for prudential regulationof the insurance sector under the
Prudential Authority. An insurer may not,without the approval of the Prudential
Authority, conduct any business otherthan insurance business in South
Africa.51 The STIA, LTIA and Insurance
Act are supplemented by their respective
regulations and Policyholder Protection
Rules published by the FSCA.
The key entities are:
• Asset Owner: Insurers are the legal ownerof the assets derived from shareholder
funds and premiums collected frompolicyholders;• Beneficiaries: An insurer’s Beneficiaries

are its policyholders, and thepolicyholders’ nominated beneficiaries,
should a claim arise. Additionally, forthe purposes of this report, we treat
shareholders of insurers as “Beneficiaries”
due to their economic interest in the
management of the insurer’s assets; and• Investment decision maker: The

investment decision maker is the insurer
itself and/or any delegated investment
manager and/or asset manager it mandates
in accordance with its investment policy, tothe extent of the delegation.

2.5.4

South African legislation is primarily
focused on treating policyholders
fairly and ensuring prudential stability.
Therefore, while each insurer would
need to consider its own situation, it isunlikely that the main duties of directorsof insurers would require them toconclude that the insurer is required touse its investment power to IFSI. However,there is flexibility and scope within
the legal framework for an insurer topursue and engage in instrumental IFSI
or discretionary ultimate ends IFSI via
its investment powers, stewardship or
public policy work, subject to obligations
to generate the financial return necessary
to discharge the insurer’s contractual
obligations, and provided it does notprejudice the customer, is in accordancewith the investment policy of the insurer,
and does not adversely impact thefinancial stability of the insurer.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

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Analysis
2.5.5

An insurer’s investment duties are shapedby, among other things:(a) the terms of policyholder documentation;(b) the requirement for an insurer and its
controlling company to, at all times:(i)

conduct its business with integrity,
and with due skill, care and diligence;(ii) act in a prudent manner;(iii) organise and control its affairs
responsibly and effectively; and(iv) deal with the Prudential Authority inan open and cooperative way;52(c) requirements to maintain its business ina financially sound condition, by holding
eligible own funds that are at least equal
to the minimum capital requirement
or solvency capital requirement, asprescribed by the Prudential Authority,
whichever is the greater;53

compliance with Prudential Standard
GOI 3 (described below);(e) duties of directors to act in good faith,
for a proper purpose, in the best interestsof the company, and with skill careand diligence.56 In exercising powers or
performing functions as a director, adirector will have satisfied obligations to
act in the best interests of the company
and with the requisite degree of skill, careand diligence if that director:(i)(f) made his or her decision with a rational
basis for believing, and did in fact believe,that the decision was in the best interestsof the company.57
This is a limited form of businessjudgement rule that affords directors
some protection from liability forbreaches of the aforementioned statutory
obligations and requires a court todefer to director’s judgement as towhat constitutes the best interests ofthe company, provided that the above
requirements were met at the time ofmaking an impugned decision; and(d) requirements to adopt, implementand document an effective governanceframework that provides for the prudent
management and oversight of:(i)in the case of an insurer, its insurance
business, and which adequately
protects the interests of its
policyholders;54 or(ii) in the case of a controlling company,
the insurance group’s business(including the business of all persons
that are part of the group), and whichadequately protects the interests ofpolicyholders of the insurers that arepart of the insurance group.55
This framework requires the adoptionof board-approved risk management
policies, including an insurer’s
investment policy prepared in422

has taken reasonably diligent steps
to become informed about thematter; and(g) duties of directors of insurers, including
those to:(i)

act in the best interests of the insurer
and policyholders; and(ii) exercise independent judgment andobjectivity in decision-making, taking
into account the interests of insurers
and policyholders.58
2.5.6

Insofar as investment activities areconcerned, the Prudential Authority has
published Prudential Standard GOI 3 inrespect of insurers’ investment policies,
which prescribes that an insurer’s

investment policy must:(a) specify the nature, role and extent of theinsurer’s investment activities, and how
the insurer will ensure compliance withthe asset requirements prescribed under
the financial soundness standards by the
Prudential Authority in the Prudential
Standard: Financial Soundness Standards
for Insurers;(b) set out the insurer’s strategy for investing,including asset allocation strategies, howthese will be managed, and how they relate
to the asset-liability management policy;(c) establish explicit risk management
procedures with regard to more complex
and less transparent classes of assets,
including investments in markets or
instruments that are subject to low levelsof governance or regulation;(d) take into account any factor which may
materially affect the sustainable longterm performance of assets, including
ESG factors;(e) adhere to the ‘Prudent Person Principle’by establishing measures that will assist in
ensuring that:(i)

the insurer invests only in assets andinstruments whose risks the insurer
can properly identify, assess, monitor,
manage, control, and report on; and(ii) assets are invested in a manner
appropriate to the nature andduration of the insurer’s liabilities
and the best interests of policyholders
and beneficiaries;(f) ensure that investments are made in amanner that ensures the security, quality,
liquidity and profitability of the insurer’s
whole portfolio;

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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REFERENCES(g) ensure that investments are diversified in
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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTIONa manner that avoids excessive relianceon any particular asset, issuer or groupof companies, or geographical area andexcessive concentration of risk in theportfolio as a whole;(h) ensure that where assets are held in respectof long-term policies, where the investment
risk is borne by the policyholders, thecorresponding liabilities are:(i)in the case of insurance obligations
that are directly linked to the valueof units, represented as closely as
possible by those units; and(ii) in the case of insurance obligations
that are linked directly to a shareindex or a reference value otherthan units, represented as closely
as possible by the units deemed
to represent the reference value
or, in the case where units are notestablished, by assets of appropriate
security and marketability whichcorrespond as closely as possible
with those on which the particularreference value is based; and(i) ensure that, in the case where investment
performance is guaranteed, appropriate
assets are held to support the guarantee.
2.5.7

2.5.8

The board of directors must ensure an
insurer maintains an appropriate level andquality of own funds commensurate withthe type, amount and concentration ofrisks to which the insurer is exposed.59
An insurer’s actuarial function is
responsible for:(a) expressing an opinion to the board of
directors regarding the accuracy of thecalculations and the appropriateness of
the assumptions underlying the valuationof the insurer’s technical provisions,423

and calculation of the insurer’s capitalrequirements; andGeneral insurance: Legal requirements to use
investment powers to Invest for Sustainability Impact

ACKNOWLEDGEMENTS(b) evaluating and providing advice to theboard of directors on various issues,
including the insurer’s investment policy
and the actuarial soundness of the terms
and conditions of insurance contracts.

2.5.11 While sustainability factors which may
materially affect the sustainable longterm performance of an insurer’s assets
should be taken into account in an
insurer’s investment policy, we do notconsider that South African law currently
supports general insurers being generally
subject to a duty or legal requirement
to exercise investment powers to IFSI.
The motivation to invest or divest in an
individual entity is likely to need to be
the anticipated financial return on thatinvestment. This is because, in relation toassets being invested in connection with
policies issued by the insurer, the directors
would be under a duty to generate thefinancial return necessary to discharge
the company’s contractual obligations
and to ensure the prudential stability ofthe business. That said, the factors thatshape the duties and investment activities
of insurers described in paragraph 2.4.5
ff above (including the requirements to
act in the best interests of the insurer andpolicyholders and to protect the interestsof policyholders) may lead an insurer toconclude it should engage in ultimate
ends IFSI in the way it manages assets inconnection with its insurance policies,
or may lead the directors to conclude
that IFSI would be in the best interests of
the insurer and its shareholders, i.e. to
conduct business in an ethical mannerthat reaches beyond financial return(alongside achieving financial returns).

EXECUTIVE SUMMARY

2.5.9

Prudential Standard GOI 3 does not define
or provide guidance on the meaning of“sustainable long-term performance ofassets” in the insurance context. Theinterpretation of the term depends on theinteraction between a particular insurer’s
board, management and statutory
actuary, which may result in a broader
meaning along the lines contemplatedin FSCA Guidance Notice 1 referred toat paragraph 2.2.22 above (which does
not purport to apply to insurers) or anarrower meaning that focuses on the“sustainability” of an asset’s risk ratingwith reference to financial impact on theportfolio capital, rather than “the abilityof an entity to conduct its business in amanner that primarily meets existingneeds without compromising the ability of
future generations to meet their needs”.

2.5.10 The National Treasury’s Sustainable
Finance Paper (discussed at paragraph1.12) recommends that the Prudential
Authority should enhance insurer’s“Own Risk and Solvency Assessment”
reporting requirements to “deal withthe management of sustainability andspecifically climate risks”. It remains to be
seen whether this recommendation will
be acted on by the Prudential Authority.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

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2.5.12 In relation to the investment of theinsurer’s own funds, although the duty
to secure a financial return would be
dependent on how the purpose of theinsurance company has been defined(and therefore what would be in the bestinterests of the insurer), it is assumed
that profit will be part of that purpose
and therefore the directors will be
under a duty to invest the insurers
assets in such a way as to generate an
appropriate financial return , which
would run parallel to any objectives to
IFSI. In specific circumstances this may
oblige an insurer, or Investment Manager
acting on its behalf, to select investment
options on the basis of the anticipatedfinancial return which effectively involve
instrumental IFSI. And there would also be
room, in our view, for an insurer to selectinvestments on the basis of anticipatedfinancial returns which involve
instrumental IFSI. For example, membersof ClimateWise, an insurance industry
group convened by the Cambridge
Institute for Sustainability Leadership,endorse principles that seek to “guide
members’ contributions to the transition
to a low carbon, climate-resilient economy
and integrate a response to the climate
risk protection gap – the growing divide
between economic and insured losses– across their business activities”.60
Members are required to take active steps
towards positive Sustainability Impacts byincorporating climate-related issues into
their strategies and investments (Principle2) and by reducing the environmental
impact of their businesses (Principle
4).61 Leading South African insurers,
Sanlam and Santam are both members of
ClimateWise. Sanlam has interests in the
Climate Investor One Fund for renewable424

energy projects and public infrastructure
projects, and a proposed Climate Investor
Two Fund, a water fund, and Santam’s
Resilient Investment Fund, which invests
in the private sector credit market with
the intention of generating financial
and social returns, are examples ofinvestments involving instrumental IFSI.62
2.5.13 An argument could be made, that directors’
duties could in certain circumstances
require an insurer’s directors to adopt
an investment policy which aims toprevent systemic sustainability risks
which may eventually negatively impact
the insurer financially (instrumental IFSI)
particularly where the insurer is exposed
to sustainability risks because of the sortof risks it insures.63 However, it would
be very difficult for a shareholder toestablish that a director had breached theirstatutory duties by failing to IFSI. South
African courts are reluctant to intervene ingood faith commercial decisions made bydirectors, and a challenge would only likely
succeed if it can be shown that the director
failed to take reasonably diligent steps to
become informed about the matter, andmade the decision without a rational basis
for believing, or did not in fact believe, thatthe decision was in the best interests of thecompany (see paragraph 2.4.5(e) above).

General insurance: Legal freedom to use investment
powers to Invest for Sustainability Impact

ACKNOWLEDGEMENTS

2.5.14 In our view, there is flexibility for ageneral insurer to conduct ultimate
ends IFSI, albeit subject to contractual
obligations, limitations in the legislativeand regulatory rules and duties of
directors to invest the insurer’s wider
assets with a view to generating anappropriate financial return. As suchthese two objectives can run parallel to
one another as insurers would be able
to engage in discretionary ultimate ends
IFSI. For example, the requirement tomaintain the business in a financiallysound condition at all times, andprudential standards, means that financial
return and impact goals would have tobe pursued in parallel. Depending on thefact-specific circumstances, this flexibility
may include scope for more selective overweighting or under-weighting investments
in individual issuers from time-to-time inorder to strengthen stewardship activities
and scope to select individual investments
for the portfolio based on the desire
to achieve a Sustainability Impact inrelation to the relevant enterprise as wellas the requisite financial return (on theassumption that this can be done in a waythat does not detract from achieving thesecurity, quality, liquidity and profitabilityof the insurer’s whole portfolio).

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

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2.5.15 Moreover, whilst the factors that shapethe duties and investment activities of
insurers described in paragraph 2.4.5
ff above do not in our view require an
insurer to IFSI, they do support flexibility
for a South African insurer to IFSI. Any
IFSI by an insurer ought to adhere to thePrudent Person Principle, which requiresthat an insurer invest only in assets andinstruments whose risks the insurer
can properly identify, assess, monitor,
manage, control and report on. Given thelack of common standards for evaluating,measuring and reporting on Sustainability
Impact, an insurer may find it difficult topursue Sustainability Impact, though thiswill become less of an issue as common
standards are developed and adopted
more widely.

Life insurance: Legal requirements to use investment
powers to Invest for Sustainability Impact

Life insurance: Legal freedom to use investment
powers to Invest for Sustainability Impact

ACKNOWLEDGEMENTS

2.5.16 The position for life insurers is generally
the same as that for general insurers
above. The motivation to invest or divest
in an individual entity is likely to need
to be the anticipated financial returnon that investment. This is due both to
the reasons set out for general insurers
above and because where a life insurance
policy contains a duty to pay an amountdetermined by reference to its success inpursuing a financial investment objective,the directors required to ensure thatappropriate assets are held to support
the guaranteed performance. Although
investment horizons are typically longer
for life insurance contracts and therefore
long-term sustainability risks more acute,
we do not consider that life insurers
are subject generally to a duty to use
investment powers to IFSI. However,in specific circumstances where IFSI isnecessary to achieve financial return, an
obligation to instrumental IFSI would arise.

2.5.17 In South Africa, the position for life
insurers is generally the same as thatfor general insurers as discussed atparagraphs paragraph 2.4.14 above. Thatsaid, while there is flexibility and scopefor a life insurer to IFSI, there would beless flexibility to do so where assets areheld in relation to life policies with astated investment objective (e.g. unitlinked funds).

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
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United Kingdom
United States

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REFERENCES

425

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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION

3.

ASSET OWNERS’ USE OF THEIR POSITION TO ENGAGE IN STEWARDSHIP ACTIVITIES TO SECURESUSTAINABILITY IMPACT

3.1

The following Section considers the extent
to which, and on what basis, each type ofAsset Owner is:Contractual obligations.
3.1.3(a) required; or(b) permitted, or able to use its position to
influence enterprises in which it invests
by engaging in stewardship activities
designed to achieve positive sustainability
outcomes and minimise negative
sustainability outcomes.
Overarching considerations
3.1.1

3.1.2

426

In general, Asset Owners’ investment
duties and powers regarding stewardshipwill be shaped by the same considerations
set out in the “Overview of investment duties
and powers” in Section 2 for each Asset
Owner, plus any additional rules specificto stewardship.
Although there is no express legal
requirement on Relevant Investors inSouth Africa to engage in IFSI stewardship
activities, IFSI stewardship activities
regarding legitimate concerns may be
important for Relevant Investors todemonstrate responsible investment
and fulfilment of their fiduciary duties.
Ultimately all Relevant Investors are
subject to the common law duty of careand given that our laws recognise thatomission can amount to unlawful conduct
in circumstances where the duty envisages
intervention, it is conceivable that in
exceptional circumstances liability may
be incurred for a failure to undertake
reasonable engagement where such
failure can be linked to consequent harmor infringement of rights. For more
information, please refer to paragraphs
7.2 and 7.3.

3.1.4

Investment Managers are often
contractually obliged to carry out
stewardship activities with reference
to ESG factors or Sustainability Impact
by their investment managementagreements/mandates.64 The scope of suchactivities will depend in part on whether
or not the mandates are discretionary or
administrative. For example, in respectof exercising voting rights at general
meetings, as a shareholder in an investee
company, an Investment Manager may
be directed by the ultimate beneficiary/investor how to exercise voting rights,
and in others the exercise of voting
rights may be left to the discretion of theInvestment Manager. Where this is thecase Investment Managers will often, inthe exercise of their discretion, take into
account any proxy/voting guidance fromthe Asset Owner.
To the extent engaging for Sustainability
Impact is required or permitted by law, it
may be challenging for a Relevant Investor
to demonstrate that the costs involved inaddressing certain systemic issues, such as
climate change, poverty or inequality, arejustifiable given the likely negligible effecta Relevant Investor acting alone could
reasonably hope to achieve. The concern
could be mitigated if Relevant Investors
were obliged, or permitted, to cooperatewith other investors.

3.1.5

There is no express requirement inSouth African law for Relevant Investors
to collaborate to instrumental IFSI or
ultimate ends IFSI.

3.1.6

While we do not think South African law

imposes a duty on Relevant Investors tocollaborate to IFSI pension funds couldin some circumstances be required tocollaborate to conduct instrumental IFSI.
In certain some circumstances a pension
fund may conclude it is legally required
to engage in stewardship to achieve
Sustainability Impact in discharging a duty
to secure financial return. Such a duty
could potentially be reached in two ways:(a) a pension fund board could conclude
that it is legally obliged to engage in
stewardship in relation to a particularinvestee enterprise where doing so canhelp the enterprise to achieve a given
Sustainability Impact which will maintainor enhance its value within an investment
portfolio; and(b) a pension fund board is subject to a duty
to ensure that the fund is financiallysound and to take all reasonable steps
to ensure the interests of members areprotected in terms of the rules of thefund and provisions of the Pension Funds
Act. The board has to act impartiality inrespect of all members and beneficiaries
and, for some members, their financial
needs are short-term and immediate,while others will not require a pension
income until long into the future. The
second category, particularly, is more
exposed to the declining sustainabilityof the environmental and social systems
on which economic activity and, hence,
financial return depends. A pension fundboard could therefore potentially be undera duty to consider what, if anything, it
can do to address these systemic risks. A
pension fund board could conclude it islegally obliged to engage in stewardship

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

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REFERENCES

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activities designed to minimise systemicrisk where investee enterprises are
creating negative Sustainability Impacts
and changing their behaviour could makea difference, or where investee companies
have the potential to create positive
Sustainability Impacts that could reduce
systemic risks.
3.1.7

3.1.8

In either of the above situations, it isunlikely that a pension fund acting
in isolation would have a reasonable
prospect of success in tackling systemicrisks at a reasonable cost. Therefore, apension fund board could conclude that
their duties require them to catalyse, orat least join existing, collective action inthis regard and it may be an efficient way
to manage risks and preserve the valueof assets.65 Indeed, many Investment
Managers in South Africa already engage
collaboratively with other Relevant
Investors to pursue stewardship andannually publish stewardship guidelines
and reports, particularly in the listed
equity space.
As noted above, the CRISA principles
recommend that an institutional investor(such as a pension fund, a CIS or an insurer)
and their Investment Managers, should:(a) incorporate sustainability considerations
into its investment and investment
analysis;(b) demonstrate its acceptance of ownership
responsibilities in its investment
arrangements and investment activities;and(c) consider a collaborative approach topromote acceptance and implementationof the principles of CRISA and othercodes.66 The proposed revised CRISA
will make stewardship principles andrecommendations more explicit (see427paragraph 1.14.2(b) above).
3.1.9

Relevant Investors engaging in collective
stewardship activity would need to do
so in a way that does not breach rules
designed to regulate collaboration in
financial markets. In our view, none ofthese rules would prohibit collaborationin all forms, and, in particular the typesof collective stewardship which are
currently commonly undertaken shouldbe permissible. However, if stewardship
activities were to become more intensive
the extent to which Relevant Investors
would need to consider the following:(a) Acting in concert. Where Relevant Investors
pursue collaborative engagement instewardship activities in relation to“regulated companies” (i.e. publiccompanies, state-owned companies, andcertain private companies incorporated
in South Africa), care should be taken
in respect of “acting in concert” rules
under the Companies Act and Takeover
Regulations promulgated under that
Act. The Companies Act regards concert
party conduct as any action pursuant
to an agreement between or among two
or more persons, in terms of which anyof them co-operate for the purpose ofentering into or proposing an affectedtransaction (statutory merger, schemeof arrangement, or a disposal of all ora greater part of a company’s assets
or undertaking) or offer. As a generalrule, provided the collaboration among
Relevant Investors is not for the purposeof proposing or entering into an affectedtransaction or offer, such conduct would
not amount to acting in concert, andthere is considerable scope for Relevant
Investors to come up with collaborative
engagement plans to conduct stewardship

activities to pursue legitimate
Sustainability Impact objectives;67(b) Concert party disclosures. If Relevant
Investors are acting in concert, certain
disclosure obligations will be triggered:after coming into concert, or coming outof concert, each involved must make adeclaration and deliver it to the regulatedcompany concerned, and to the Takeover
Regulation Panel;(c) Mandatory offer requirements. Additionally,
concert party conduct by a Relevant
Investor could trigger a requirement
for it to make a mandatory offer to theremaining shareholders of the investee
company if the Relevant Investor (orits concert party) acquires a beneficial
interest in voting rights attaching to theregulated company’s securities with theresult that its beneficial interest (alone
or aggregated that of its concert parties)
increases to 35% or more;68(d) Disclosure and transparency rules. Thereis a risk that collective shareholder
action in respect of listed securities may
trigger notification obligations regarding
combined shareholdings or aggregated“beneficial interests” in listed securities;69(e) Insider trading and market abuse. The
Financial Markets Act, 2012 (FMA)
includes rules prohibiting insider trading
and market abuse.70 Relevant Investors
must adhere to these provisions whenpursuing stewardship activities, whether
alone or collaboratively with other
Relevant Investors, or risk sanctions.
Whilst engaging in stewardship activities,
a Relevant Investor may become an“insider” by becoming privy to “inside
information” for the purposes of the
FMA, at which point insider trading rules
would apply to it. The FMA defines “inside

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

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information” as “specific or precise
information, which has not been madepublic and which –(i)is obtained or learned as an insider;and(ii) if it were made public, would be
likely to have a material effect on theprice or value of any security listed
on a regulated market”;(f) Competition / Antitrust. Collaboration
between competitors amounting to pricefixing, collective boycotts, or the sharingof territories, markets and customers is
prohibited outright, and even a first-time
contravention can result in significant
administrative penalties being imposed.
These arrangements cannot be justified
on the basis that they give rise to procompetitive, efficiency or technologicalbenefits.71 There is no specific exemption
for arrangements designed to achieve
Sustainability Impact;
Where Relevant Investors are competitorsand seek to engage collaboratively instewardship activities, they should takecare to ensure that no competitively
sensitive information is shared between
them in contravention of applicablecompetition rules, or in a manner that
could facilitate anti-competitive conduct.
However, there remains a wide rangeof collaborative actions that Relevant
Investors may take, as long as they do not
result in or amount to price-fixing, market
allocation or collusive tendering, and do
not result in a substantial lessening or
prevention of competition in any relevantmarkets (or if it does, these effects areoutweighed by its pro-competitive,
efficiency or technological benefits). These
include, for example:
428

(i)

collaboration towards non-binding
and non individualised sustainability
targets (especially where parties areafforded a high level of discretion as
to the means by which they attainsuch an objective);

mitigate and disclose the conflict
to its clients. Similar requirements
apply to CISs under Board Notice 92
of 2014;(iii) An insurer would need to consider
conflicts of interests when conducting
stewardship, for example, between its
shareholders and its policyholders,and as between policyholders; and(ii) joint initiatives to develop standard
investment classification ormeasurement tools (provided there
are fair and equal rights to their use);(h) Investment Managers. The Discretionary
Code prohibits an Investment Manager
from directly or indirectly, without therelevant client’s prior written approval
exercise voting rights on behalf of clientsto gain control of a listed or unlistedcompany, except where such voting rights
are exercised to protect the interests ofclients on whose behalf the financial
products involved are held as investments
or on the instructions of such clients.

(iii) exchanging information and bestpractice insights on IFSI (provided
the information is not competition
sensitive);(iv) joint initiatives to enable the rise of
new markets and services; and(v)

joint advocacy/dialogue with policy
makers and stakeholders.72(g) Conflicts of interest. In engaging in
stewardship activities, Relevant Investors
must take care in identifying and dealing
with any actual or potential conflicts ofinterest:(i)A pension fund would need toconsider conflicts of interest as
between Beneficiaries (noting that it
may be fairer as between different
cohorts of Beneficiaries to spreadcertain costs, such as the transition
costs of climate change, over multiple
generations by taking early action,rather than a “cliff-edge” which
would be extremely costly for the
relevant generation);(ii) Under General Code Board Notice
92 of 2014, to the extent that a
relationship between an Investment
Manager and an issuer may constitutea conflict of interest, the Investment
Manager would be required to avoid
such conflict and, if unavoidable,

Pension funds

3.2

Legal requirements to engage for Sustainability
Impact
3.2.1

3.2.2

For the reasons set out at paragraph1.1.1 above, we do not consider that theboards of pension funds are generally
subject to a duty to engage in stewardship
activities for Sustainability Impact. The
requirement under Regulation 28 for a
pension fund when invested in an asset
to consider factors, including ESG factors,
which may materially affect the long term
sustainable performance of an asset does
not amount to a requirement to conduct
stewardship for Sustainability Impact.
That said, FSCA Guidance Notice 1
recommends that a fund’s IPS and afund’s investment mandate reflects,
among other things:

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES(a) how the fund intends to monitor andevaluate the ongoing sustainability of theFreshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION

asset which it owns (or which it intends
to acquire), including the extent to which
ESG factors have been considered by thefund, and the potential impact thereof on
the assets of the fund; and(b) the fund’s active ownership policy.73 It
defines “active ownership” as the prudent
fulfilment of responsibilities relating tothe ownership of, or an interest in, an
asset. These responsibilities include, but
are not limited to:(i)situations similar to those described inparagraph 3.1.5 above, that it is required
to conduct instrumental IFSI and engage
in stewardship for Sustainability Impact.
Legal freedom to engage for Sustainability Impact
3.2.5

guidelines to be applied for theidentification of sustainability
concerns in that asset;(ii) mechanisms of intervention andengagement with the responsible
persons in respect of the asset whenconcerns have been identified and themeans of escalation of activities as aholder or owner of that asset if theseconcerns cannot be resolved; and(iii) voting at meetings of shareholders,owners or holders of an asset,
including the criteria that are used
to reach voting decisions and themethodology for recording voting.
3.2.3

3.2.4

429

Where a fund holds assets that limit theapplication of ESG factors, sustainability
criteria or the full application of anactive ownership policy, the IPS should
state the reasons why the limitationis advantageous to the fund and its
members. Alternatively, the IPS should
set out the remedial action the fund hastaken (or intends to take) to rectify the
position. If no such remedial action is
being considered or taken, the fund may
set out the reasons for that.
Bearing in mind the above guidance andrecommendations, the board of a pension
fund could conclude, for example in

3.2.7

3.2.6

In our view, there is flexibility within
the law to engage in stewardship for
instrumental IFSI or ultimate ends IFSI,
subject to the overriding duty to ensure
the fund is financially sound and protect
the interests of members. Guidance Notice
1 appears to focus on sustainability on anasset by asset basis. Such activities could
be addressed in a fund’s active ownershippolicy. The potential costs and benefitsof proposed stewardship activities would
have to be borne in mind in light of theduties to ensure the fund is financiallysound and protect the interests ofmembers, as well as the potential issues
described at paragraph 3.1.8 above wherecollaborative engagement is pursued.
While there is no legal requirement toascertain Beneficiaries’ views on IFSI,
Beneficiaries’ sustainability preferences
or a wider measure of Beneficiary
welfare than solely financial welfare may
be relevant to a pension fund board’s
decision to conduct ultimate ends IFSI
stewardship.
Stewardship activities are relatively
common practice, with King IV, and theprinciples in CRISA and UN PRI setting
good practice standards. In practice,very few pension funds conduct direct
stewardship activities; instead suchactivity, and even the specific philosophy
and approach for stewardship, is usually
outsourced to the Investment Manager
to deal with pursuant to its contracted
stewardship and ESG undertakings to the
fund.

3.3

In appointing and mandating an
Investment Manager for these purposes, apension fund should take reasonable steps
to ensure that the Investment Manager
has the resources and ability to engage
in the manner required, that it is not
subject to conflicts of a sort that are likely
to prejudice its activities, and that theInvestment Manager’s stewardship policy
is sufficiently aligned with the objectives/
active ownership policy of the pension
fund. It should also consider taking
remedial action when that is not the case.
Mutual funds

Legal requirements to engage for Sustainability
Impact3.3.1

In our view, for the reasons set out inparagraph 2.3.9 above, CISs are notgenerally subject to a duty to engage in
stewardship for Sustainability Impact.
That said, it is conceivable that a CIS
manager could, given the specific CIS
deed and facts specific to its situation(including the obligation to manage
assets in terms of deed of the CIS, and in
the best interests of investors), conclude
that it is subject to a duty to engage in
stewardship for instrumental IFSI or
ultimate ends IFSI. This duty may beof general application or specific, forexample where engaging in instrumental
IFSI or ultimate ends IFSI stewardship
activity could protect its portfolio from amaterial adverse financial impact, and it
is likely to be in the interests of longerterm investors in the fund (for example,
pension funds invested in the CIS) for
its value not to be damaged by systemic
sustainability risk (i.e. as a result of thedeclining sustainability of the market
being benchmarked).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

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Legal freedom to engage for Sustainability Impact

3.4

3.3.2

Legal requirements to engage for Sustainability
Impact3.3.3

430

There is scope for a CIS to engage in
stewardship for Sustainability Impact,subject to any limitations inherent in
the CIS’s deed and investment objectives(including subject to any requirements togenerate a financial return in accordancewith those objectives). The potential issues
described at paragraph 3.1.7 above would
also be relevant to a CIS’s engagement
activities. While there is no legal
requirement to ascertain Beneficiaries’
views on instrumental IFSI or ultimate
ends IFSI which is aligned with the CIS’s
investment objectives, Beneficiaries’
sustainability preferences or a wider
measure of Beneficiary welfare thansolely financial welfare may be relevant
to a CIS manager’s decision to conduct
stewardship for instrumental IFSI or
ultimate ends IFSI.
In appointing and mandating an
Investment Manager to carry out
stewardship for Sustainability Impact, a
CIS manager should take reasonable steps
to ensure that the Investment Manager
has the resources and ability to engage
in the manner required, that it is not
subject to conflicts of a sort that are likely
to prejudice its activities, and that theInvestment Manager’s stewardship policy
is sufficiently aligned with the objectives/
active ownership policy of the CIS
manager. It should also consider taking
remedial action if and when that is not
the case.

Insurance undertakings

3.4.1

For the reasons set out at paragraph 2.4.5
ff above, we do not consider that life or
general insurers are generally subject
to a duty to engage in stewardship for
Sustainability Impact.

3.4.2

That said, an insurer that is exposed tosustainability risks may conclude that itis required, either generally or in specificcircumstances, to engage in stewardshipfor instrumental IFSI. Insurers may alsochoose to endorse the CRISA principles. The
discussion at paragraph 2.4.11 above applies
equally to the engagement decision-making
process of insurers and, as indicated there,
depending on their particular circumstances,the directors of an insurer could conclude
that it is necessary to, for example, toengage with one or more investor companies
in relation to a sustainability risk (suchas climate change) or with a particularsystemically important company in orderto achieve their investment goal and staywithin their risk appetite.

3.4.3

For example, where an insurer concludes
that sustainability factors present a systemicrisk which could prevent it from ensuringthat the fund is financially sound overthe long-term, the board could conclude
that it should engage in stewardshipfor Sustainability Impact with investee
enterprises designed to avert that risk, solong as such investment decisions are madein accordance with the insurer’s investment
policy and comply with the insurer’s duties
outlined in the Prudential Standards. In that
context, it might also conclude from timeto-time that it should under or overweighta particular investee company in order tostrengthen its voice as part of those activities.

Legal freedom to engage for Sustainability Impact
3.4.4

3.4.5

3.4.6

In our view, both life and general insurers
have flexibility to engage in stewardship
activities for ultimate ends IFSI in certain
circumstances, subject to the duties andrequirements described at paragraph 2.4.5
ff above, including the requirement tomaintain their business in a financiallysound condition. The former have alittle less flexibility, given the overlay ofpolicy terms and related policyholder
protections, which add complexity.
Stewardship activities for Sustainability
Impact may be incorporated into an
insurers’ investment policies. Prudential
Standard GOI 3 requires an insurer’s
investment policy to “specify the nature,role and extent of the insurer’s investment
activities”, “set out the insurer’s strategy
for investing” and “take into account any
factor which may materially affect thesustainable long-term performance ofassets”, including ESG factors which leaves
scope for IFSI.
In appointing and mandating an
Investment Manager to carry out
stewardship for Sustainability Impact,
an insurer should take reasonable steps
to ensure that the Investment Manager
has the resources and ability to engage
in the manner required, that it is not
subject to conflicts of a sort that are likely
to prejudice its activities, and that theInvestment Manager’s stewardship policy
is sufficiently aligned with the objectives/
active ownership policy of the insurer.
It should also consider taking remedialaction if and when that is not the case.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

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4.

ASSET OWNERS’ ENGAGEMENT IN PUBLIC POLICY WORK TO SECURE SUSTAINABILITY IMPACT

4.1

The following Section considers the extent
to which, and on what basis, each type ofAsset Owner is:(a) required; or(b) permitted or able to use its position to
engage in public policy work designed toachieve positive sustainability outcomesand minimise negative sustainability
outcomes, for example, where these are
relevant to the value of portfolio assets.

4.2

Pension funds

4.2.1

There is no express requirement in South
African law for pension funds to engage
in public policy work with a view to
IFSI. We do not consider that boards ofpension funds are generally subject to a
duty to conduct public policy work for
Sustainability Impact, but in our view,
they would have the flexibility to do so.
This is not to say that circumstances may
not arise (for example, those described inparagraph 3.1.5 above) where the board ofa pension fund may feel it is required toengage in public policy for IFSI.

4.2.2

431

The board of a pension fund is required
to take all reasonable steps to ensure thatthe interests of the fund’s members (asa collective) in terms of the rules of thefund and the provisions of the Pension
Funds Act are protected. There may
be circumstances in which engaging
in policy discussions and lobbying
policy makers with a view to achieving
positive and/or minimising negative
Sustainability Impacts, is consistent withthis requirement. While there is no legal
requirement to ascertain Beneficiaries’
views on IFSI, Beneficiaries’ sustainability
preferences or a wider measure ofbeneficiary welfare than solely financial

welfare may be relevant to a pension fundboard’s decision to conduct ultimate ends
IFSI public policy work.
4.2.3

4.3

Mutual funds

4.3.1

We do not consider CISs to be generally
subject to a duty to conduct public policy
work for Sustainability Impact. While
such public policy work is not prohibited,a CIS may be restricted by its investment
objectives and the terms of its deed. Costs
considerations may also restrict suchactivities, where they can be pursued by a
CIS. While there is no legal requirement
to ascertain Beneficiaries’ views on
instrumental IFSI and ultimate ends IFSI,
Beneficiaries’ sustainability preferences
or a wider measure of beneficiary welfare
than solely financial welfare may be
relevant to a CIS manager’s decision to
conduct instrumental IFSI or ultimate
ends IFSI public policy work.

Associations such as the Batseta Council
for Retirement Funds, the Institute for
Retirement Funds Africa and ASISA offer
platforms for such policy engagement,
including participation in technicalworking committees with the FSCA andtax authorities, and those and similar
associations have occasion to engage inforums like NEDLAC and other summitstyle forums with national policy makers
regarding the macro-economic environment
for retirement funds, including the themeof Sustainability Impact.

4.3.2

National Treasury’s Sustainable Finance
Paper recommends in respect of CISs,
among other things, the “identificationof financial policy innovations in order
to increase sustainable or green financein SA”, and that industry and regulators“increase technical collaboration”.74 In
practice, many of the large Investment
Managers that operate CISs will engage
in policy work for Sustainability Impact,
funded from their own resources, aspart of their own responsible businesspractices. They may do so acting alone
or collaboratively with other Investment
Managers.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION

4.4

Insurance undertakings

4.4.1

There is no express requirement in South
African law for insurers to engage inpublic policy work to IFSI. We do notconsider general or life insurers to be
subject to a duty to conduct public policy
work for Sustainability Impact. However,there may be circumstances where an
insurer is exposed to sustainability risks(for example climate change related risks)such that its board concludes that it isrequired to engage in public policy with aview to IFSI.

4.4.2

4.4.3

4.4.4

432

Insurers do have sufficient flexibility to
conduct public policy work to IFSI, fundedfrom their own resources; provided thatthey do so in a manner that does notprevent an insurer complying with its
statutory and regulatory obligations (suchas financial soundness requirements, andmeeting obligations to policyholders)and consistent with directors’ duties. We
cannot easily identify a conflict in doing
this between the interests of the insurer
and the duties it owes its policyholders.
Any conflicts of interest that are identified
would need to be considered andmanaged.
The costs of such public policy
engagements would need to be assessedagainst the likely benefits. Again,
collaborative public policy engagementswith other insurers or through industry
associations are an option that insurers
may consider.
The ClimateWise initiative (referred to atparagraph 2.4.12 above), of which
Sanlam and Santam are members,
encourages members to disclose how
they “inform public policy making” onclimate-related issues.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

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5.

ESTABLISHING NEW FUNDS TO INVEST FOR SUSTAINABILITY IMPACT AND AMENDING THE
TERMS OF EXISTING ONES

5.1

The following Section considers the extent
to which it is possible for an Asset Owner
to set up a fund, policy or other productwith the express objective of IFSI.

5.2

Pension funds

5.2.1

It is permissible for a pension fund tohave a mandate to IFSI either as well as,or having priority over, financial return,to some extent. Funds are not-for-profit
legal entities which aim to achieve
and maintain sustainable long-term
performance. Provided that a fund isfinancially sound it may feasibly adopt
and pursue a strategy that includes or
prioritises Sustainability Impact. The
regulatory framework contemplates
responsible investment approaches anda mandate to IFSI would not necessarily
be inconsistent with the requirements ofRegulation 28. The Registrar of Pension
Funds may of course impose conditions
or restrictions on a fund with such a
mandate at its registration.

5.2.2

433

Retirement funds that provide for“member investment choice” (in which
members may choose from a range
of investment strategies / investment
portfolios) may include portfolios thatprioritise Sustainability Impact (provided
the fund remains financially sound). In
the ordinary course, a fund’s “default
investment strategy” applies to allmembers unless a member chooses his or
her own investment strategy or portfolio.

5.3

Mutual funds

5.3.1

A CIS may set up a portfolio/sub-fund withthe express objective of instrumental IFSI
or ultimate ends IFSI either as well as, or
having priority over, financial return. The
portfolio/sub-fund (and its investment
objective) would have to be registeredunder CISCA by the FSCA. As mentioned
above, the FSCA may impose conditions or
restrictions on such a portfolio/sub-fundon its registration. Additionally, the CIS
deed would need to expressly document
the investment objective to instrumental
IFSI or ultimate ends IFSI. The investment
objective to instrumental IFSI or ultimate
ends ISFI would need to be disclosed toinvestors prior to their investing in theportfolio/sub-fund.

5.3.2

5.3.3

Insofar an existing CIS is concerned,
the investment policy of a CIS may beamended by amending the deed subject to
the FSCA’s approval. No amendment will
be valid unless consent of a majority invalue of investors has been obtained in themanner prescribed in the deed.
It must be borne in mind that a CIS withan object to instrumental IFSI or ultimate
ends IFSI may encounter difficulties inmeasuring and valuing Sustainability
Impact, which may result in regulatorycompliance challenges. There are detailed
requirements regarding the valuationof participatory interests in CISs andthe disclosure thereof. For example,
Schedule 1 of CISCA requires that a deedmust contain provisions regarding themanner in which the assets of a portfolio
are to be valued for the purposes ofcalculating the selling and repurchaseprices of participatory interests. The lackof standardised and generally accepted
methods of measuring or evaluating nonfinancial factors such as Sustainability
Impact may give rise to difficulty. It could
also make it difficult for Beneficiaries tocompare and evaluate the performance ofa CIS.
5.4

Life insurance products

5.4.1

It is permissible for an insurer to set up
a fund or other vehicle that IFSI either aswell as, or having priority over, financial
return, on the assumption that it has been
financially modelled. The insurer would
need to reflect the investment approachin its board approved investment policy,
which must address how the insurer will
ensure compliance with the financial
soundness requirements under the
Insurance Act, i.e. maintain its businessin a financially sound condition, whilepursuing ultimate ends IFSI.

5.4.2

5.4.3

There is no prohibition on life insurers
from setting up a life fund / insurance
wrapper / linked policy that pursues
ultimate ends IFSI either as well as, or
having priority over, financial return inwhich targeted investors or beneficiaries
can choose to invest, or by reference towhich have their benefits determined. The
investment policy of the Insurer requiredby Prudential Standard GOI 3, as explainedin our response at paragraph 2.4.6
above, must be borne in mind, as well as
Policyholder Protection Rules.
Amendment to policy documents toincorporate an express IFSI objective
typically requires policyholder consent.
Gaining consent may only be practical in

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B. THE EXTENT TO WHICH
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relation to those types of policy held bya single policyholder. For other types ofpolicy, the policyholder outreach required
to incorporate IFSI into a significant
proportion of an insurer’s existing policies
may nonetheless make such amendment
impracticable.
Duties on those designing, manufacturing andproviding insurance
5.4.4

5.4.5

In terms of the Policyholder Protection
Rules (Long-Term Insurance), 2017 andPolicyholder Protection Rules (ShortTerm Insurance), 2017 (Policyholder
Protection Rules) (this rule applies to thedevelopment of any new products and any
material change in design of an existingproduct), an insurer must in developing
products, among other things, make useof adequate information on the needs ofidentified types, kinds or categories ofpolicyholders or members.
The fair treatment of policyholders
encompasses achieving the following
outcome (among others): “products aredesigned to meet the needs of identified
types, kinds or categories of policyholders
and are targeted accordingly”.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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6.

INVESTMENT MANAGERS’ DUTIES TO INVEST FOR SUSTAINABILITY IMPACT

ACKNOWLEDGEMENTS

6.1

This Section considers the extent towhich, and in what circumstances, an
Investment Manager is:

EXECUTIVE SUMMARY(a) required; or(b) permitted to instrumental IFSI or ultimate
ends IFSI on behalf of an Asset Owneror otherwise, in each of the three ways
contemplated in Sections 2 to 4.
6.1.1

Typically, an Investment Manager’s
investment powers and duties are shapedby:(a) the terms of its contractual investment
management agreement (IMA) with an
Asset Owner. The terms of such IMAs tend
to be heavily influenced by the regulatory
requirements applicable to the financial
product or service being provided. The
IMA will typically specify:(i)investment objective(s) against
which the Investment Manager’s
performance (and performance
related remuneration) will beassessed;(ii) the Investment Manager’s mandate(discretionary or non-discretionary);(iii) any investment strategy specified by
the Asset Owner;(iv) any investment parameters or
restrictions; and(v)

any contractual standard of care;(b) statutory obligations in that Investment
Managers, as financial service providers(FSPs), are regulated by the Financial
Advisory and Intermediary Services Act,37 of 2002 (FAIS);(c) the FIA, mentioned at paragraph2.3.8 above, which prohibits financial
institutions or nominees which administer435

trust property from causing it to beinvested otherwise than in a manner
directed in or required by the IMA orinvestment mandate;(d) applicable codes of conduct publishedunder FAIS, with which an Investment
Manager must take reasonable steps
to ensure that its representatives
comply.75The General Code of Conduct for
Authorised Financial Services Providers
and Representatives, 2003 (General Code),among other things:(i)client; and(e) duty of care to the Asset Owner in delict(tort), requiring the exercise reasonablecare and skill in the carrying out ofservices.
6.2

Powers of investment and divestment
6.2.1

places a general duty on Investment
Managers to, at all times, renderfinancial services honestly, fairly,
with due skill, care and diligence,and in the interests of clients andthe integrity of the financial services
industry;(ii) spells out various duties that
Investment Managers must comply
with when rendering a financial
service, including that the service
must be rendered in accordance withthe contractual relationship andreasonable requests or instructionsof the client, which must be executed
as soon as reasonably possible andwith due regard to the interests ofthe client which must be accorded
appropriate priority over any
interests of the Investment Manager;(iii) obliges an Investment Manager thatreceives funds or holds financial
products on behalf of a client totake reasonable steps to ensure thatat all times such financial products
or funds are dealt with strictly inaccordance with the mandate given
to the Investment Manager by the

Legal obligations with respect to
Sustainability Impact

6.2.2

6.2.3

6.2.4

Investment Managers are legally required
to ascertain a client’s investment
objectives before concluding an
investment mandate with the client.
Where an IMA (including those informed
by a pension fund’s IPS or an insurer’s
investment policy) requires instrumental
IFSI or ultimate ends IFSI, the Investment
Manager is obliged to pursue a strategy
which complies with such requirements,
subject to applicable laws and any
restrictions or limitations imposed on
it by the IMA and its licence granted
under FAIS. Investment Managers will beconcerned to ensure that the mandate
specifies how any Sustainability Impact
objectives should be balanced withthe financial objectives to minimise
its exposure to complaint and possible
litigation.
Where the mandate is silent as to
Sustainability Impact, we do not consider
that an Investment Manager would be
subject to a duty to instrumental IFSI or
ultimate ends IFSI.
As regards powers of investment ordivestment, an Investment Manager’s
duties would follow the terms of its
mandate.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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REFERENCES

If the Asset Owner wishes to incorporate
instrumental IFSI or ultimate ends
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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTIONIFSI, the IMA should be amended toincorporate these, as non-contractual
discussions would remain subordinate to
the terms of the IMA.
6.2.5

Impact6.3.1

Although an Investment Manager is not
generally subject to a legal obligation
to contribute to B-BBEE (see footnote 33
above), it may (on its own initiative as acorporate citizen) seek to achieve improve
its B-BBEE contribution through its own
activities.

Engagement to achieve Sustainability Impact
6.2.6

The Investment Managers’ duties inrespect of a specific client would follow
the terms of its mandate. Where an
Investment Manager’s mandate is silent
as to Sustainability Impact, we do notconsider there to be any legal requirement
for the Investment Manager engage towith portfolio companies to achieve
Sustainability Impact.

Public policy work to achieve Sustainability Impact
6.2.7

6.2.8

6.3
436

As above, an Investment Manager’s
duties in respect of a specific client would
follow the terms of its mandate. Where
the mandate is silent as to Sustainability
Impact, we do not consider there to be
any legal requirement for Investment
Managers to engage in public policy work
to IFSI.
Should Investment Managers (in theirown capacity as corporate citizens) wish toengage to achieve Sustainability Impact,
they are able to do so, whether that bewith the respective Asset Owner and/orthat Asset Owner’s clients, the FSCA, orother stakeholders. For those Investment
Managers who are ASISA members, theengagements may be bolstered and guided
by such membership.
Legal freedom to Invest for Sustainability

relationship, any reasonable requests
or instructions of the client, which may
include requests or instructions withregard to Sustainability Impact. Any suchreasonable requests or instructions must
be executed as soon as reasonably possible
with due regard to the interests of theclient.77

Powers of investment and divestment

6.3.2

6.3.3

There is no explicit prohibition on an
Investment Manager exercising powers
of investment to instrumental IFSI or
ultimate ends IFSI. However, where the
IMA is silent on instrumental IFSI or
ultimate ends IFSI, it may be challenging
to do so in light of an Investment
Manager’s duties. Financial return-based
objectives (perhaps by reference to abenchmark) and related remuneration
structures for the Investment Manager
may militate against considerationof Sustainability Impact. Investment
Managers may be reluctant to consider
factors additional to financial return
absent clear instructions to do so as it
may expose them to litigation risk if thepractical outcome is reduced returns. Of
course, Investment Managers would not
be precluded from speaking in favour of
instrumental IFSI as a means to achieving
financial return in specific circumstances.
Investment Managers are not generally
obliged to offer sustainability-focussed
products to Asset Owners but are free
to do so, and it may be consideredgood practice. In this regard, CRISA
recommends that institutional investors(Asset Owners such as CISs, pension
funds, and insurers) and Investment
Managers (as service providers “shouldincorporate sustainability considerations,
including ESG, into its investment analysis
and investment activities as part of thedelivery of superior risk-adjusted returns
to the ultimate beneficiaries”).76
The General Code requires Investment
Managers to render financial services
to the Asset Owner client in accordance
with, in addition to their contractual

6.3.4

The Investment Manager and Asset
Owner could agree to amend the termsof an existing IMA to instrumental IFSI
or ultimate ends IFSI. There are no
limitations on the Investment Manager’s
ability to do so, but the extent to whichsuch an objective may be pursued depends
in part on:(a) the nature of the Asset Owner, and its own
power and capacity to pursue an objectiveof instrumental IFSI or ultimate ends IFSI;(b) regulatory limits or restrictions applicableto the Asset Owner;

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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ANNEXESJURISDICTION REPORTS

Australia

Brazil(c) the Asset Owner’s obligations to its
Beneficiaries; andCanada(d) whether investment mandate isadministrative or discretionary (full or
specified limited discretion).

European Union

6.3.5

Should Investment Managers (in theirown capacity as corporate citizens)wish to engage in public policy work to
instrumental IFSI or ultimate ends IFSI,
they are able to do so.

Engagement to achieve Sustainability Impact
6.3.6

Given the general duty on Investment
Managers at all times to render financial
services in the interests of clients andthe integrity of the financial services
industry; and since stewardship activities
are less likely to affect the compositionof an investment portfolio, there may
be more scope to pursue Sustainability
Impact through stewardship activities,

China

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even where the IMA is silent upon the
point. However, the Investment Manager
would have to ensure that such actions do
not bring its obligations to one client into
conflict with the duties it owes to otherclients (without appropriate disclosures or
waivers in place).
6.3.7

6.3.8

Costs are also a consideration. Investment
Managers will need to conduct cost-benefit
analyses for their portfolios in respect ofengagement for Sustainability Impact. As
discussed above at paragraph 3.1.3 above,the costs associated with engagement may
be easier to justify where the engagement
is collaborative. So too are the investment
horizons of the IMA; a shorter investment
horizon may entail less flexibility forengagement for Sustainability Impact
where financial return is prioritised.
Insofar as good practice is concerned,
CRISA encourages a collaborative
approach by institutional investors,
including Investment Managers, topromote acceptance and implementationof the principles of CRISA and other codesand standards applicable to institutional
investors. It is increasingly common
practice in South Africa for Investment
Managers to engage co-investors in
relation to promotion of positive, andmitigation of negative, Sustainability
Impacts. See discussion at paragraph 3.1.3
to 3.1.7 above.

Public policy work to achieve Sustainability Impact
6.3.9

Investment Managers are not generally
required to engage in public policy workto achieve Sustainability Impact. An
Investment Manager is broadly free toengage in public policy work on its own
behalf, funded from its own resources
provide that doing so:best interests of the company; and(b) does not create a conflict of interest
between the Investment Manager andits clients (or between the duties owed
to various clients, to the extent any
such work is undertaken on any of theirbehalf).
6.3.10 Where an Investment Manager isundertaking public policy work on behalfof a client, it will need to ensure that it
does so in compliance with its mandate
and any conflicts of interest between
clients, or between itself and clients, areappropriately managed.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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REFERENCES(a) is considered by the directors to be in the437

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7.

LEGAL LIABILITY TO THIRD PARTIES FOR THE NEGATIVE SUSTAINABILITY IMPACT OF
ENTERPRISES IN WHICH PORTFOLIOS ARE INVESTED

7.1

This Section considers the extent to which,regardless of the legal rules under which itis required to operate and its constitution,
an Asset Owner could be legally liable tothird parties for the negative Sustainability
Impact of enterprises in which it invests,
and whether an Investment Manager could
also be liable because of its role in assisting
the Asset Owner to invest in the relevant
enterprise and steward its investment.

7.2

Asset owners

7.2.1

It is possible that Asset Owners could befound to have criminal or civil liability to
third parties for negative Sustainability
Impact of assets in which they are
invested. While this is generally likely
to be a remote risk, the risk of this typeof litigation may well be increasing as aresult of the increasing political focus onsustainability issues, which has prompted
growing scrutiny from regulators, nongovernmental organisations (NGOs) andthe public.

Criminal liability
7.2.2

438

It is unlikely that an Asset Owner would
be held criminally liable for the negative
Sustainability Impact of an enterprise it
has funded. In exceptional circumstances
primary criminal liability might exist
where an Asset Owner has direct
involvement in the investee company’s
activities or operations, and where thoseare determined to be criminal under
the relevant legislation (for example,
failure to take reasonable measures toprevent pollution or polluting water
resources).78However, the arm’s length
nature of relationships between an Asset
Owner and the activities of the enterprises

included in its portfolio makes such aliability highly unlikely. The risks would beslightly higher if an Asset Owner had close
day-to-day involvement in and direction
over the activities of the investee company.
7.2.3

Secondary liability is also theoreticallypossible, for example, if a nominee
director appointed by an Asset Ownerassumed managerial responsibility
over relevant activities of the investee
company, and consented to or connived
in an illegal act or omission (such aspollution of a waterway, or operation of aregulated facility without the appropriate
environmental permit). However, only
exceptionally would an Asset Owner
exercise the required level of engagement
in a portfolio company’s operations to
attract this type of liability.

care is relatively wide and includes landowners, persons in control of land orentities which causes pollution and thosewith land use rights. A similar duty ofcare applies under the National Water Act,36 of 1998 in relation to water pollution.
An Asset Owner and/or Investment
Manager liability may be established if it
is shown they are “in control” of an entity
or activity which causes pollution (e.g.
through holding equity, involvement inmanagement, oversight of a project, or the
exercise of step-in rights). The standardof care will be assessed on a case by casebasis and depend on the facts of eachparticular scenario.
7.2.5

Civil liability
7.2.4

It is possible that, in certain limited
circumstances, an Asset Owner could
be found to have a duty of care towards
persons harmed by an investee company’s
acts or omissions which result in negative
Sustainability Impact, i.e. liability innegligence. For example, South Africa’s
National Environmental Management Act,
1998 (NEMA) recognises an environmental
duty of care, which places an obligation
on everyone who causes, has caused or
who is likely to cause significant pollution
or degradation to the environment totake reasonable measures to preventor stop such harm to the environment,
or where the harm is authorised underlaw or cannot reasonably be avoided, tominimise and/or rectify such pollution ordegradation.79 The ambit of this duty of

7.2.6

The NEMA allows a person or group of
persons to seek appropriate relief for any
breach or threatened breach of statutes
concerned with environmental protectionor the use of natural resources, whether
in their own interest, the public interest,
the interest of a class of persons (classactions are recognised in South Africa), orin the interests of the environment itself.80
For liability to arise the claimant(s) would
need to prove the elements of a delict(conduct, wrongfulness, fault, causationand damage). Of these elements, causation(i.e. that the caused the harm) is often themost difficult to prove.
There are, however, challenges when it
comes to the enforcement of the duty ofcare, including in respect of causation,
the measure of damages, the attachment
to and proving of liability of a particularperson. The likelihood of liability innegligence for a minority shareholder(as an Asset Owner would typically be) is
fairly remote: not only must the harm

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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caused by the negligent act or omission
have been reasonably foreseeable, butthere must be sufficient proximity
between the parties (i.e. between the Asset
Owner and the investee company whichcauses harm, which would likely require a
degree of direct involvement or operation
control on the part of the Asset Owner),and it must be reasonable to recognise
the conduct as wrongful and therefore
attracting liability, based on policy andthe legal convictions of the community
to impose liability to a third party on theinvestor entity. Generally speaking, it isunlikely that these requirements would
be met in relation to the usual activities
of an Asset Owner of the type described inthis report.
7.2.7

7.2.8

7.2.9

439

Certain environmental statutes requiredevelopment of certain infrastructure to
be authorised prior to development andfailure to obtain requisite authorisation
would attract significant sanctions. If aperson fails to comply with the duty of careor permitting obligations imposed by thesestatutes, such failures may attract civil
liability and the environmental perpetrator
may have to pay a fine and/or remedy theharm done to the environment.
Separately, direct clean-up/remediation
liability can be incurred where a person
causes or negligently fails to prevent
pollution. Again, though, there would
need to be some element of “control” orinvolvement at operational level by the
Asset Owner to incur liability.
The potential of liability for an Asset
Owner means that Asset Owners inSouth Africa have become accustomed
to carrying out due diligences andconsidering the ESG risk of an enterprise/
project in deciding whether to invest/fund.

Regulatory and reputational risks
7.2.10 Aside from litigation risks, South Africa’s
environmental and other NGOs areactive in seeking to hold companies andinstitutional investors to account withregard to Sustainability Impact anddisclosures.81 There is a developing trendof shareholder activism in respect ofnegative Sustainability Impact, from NGOs
but also other institutional investors.
Recent campaigns by NGOs have sought
to have resolutions tabled at listedcompany AGMs, which would require
the companies to disclose and/or reportto shareholders on: climate risk; plans toaddress climate-related transition risks;assessments of greenhouse gas emissions
in financing portfolios; and policies on
lending to coal-fired power projects andcoal mining operations, oil & gas, orcarbon-intensive, fossil fuel activities andcommit to a hard deadline for enhanced
disclosures related to climate risk. Suchcampaigns have the potential to causesignificant reputational damage to theinvestee companies and/or Asset Owners
invested in them.
7.3

Investment managers

7.3.1

It is even less likely that Investment
Managers, as agents of their client
Asset Owners, would be found to haveliability to third parties for the negative
Sustainability Impact. However, as for
Asset Owners above, the risks of such
litigation is increasing.

Criminal liability
7.3.2

As for an Asset Owner, an Investment
Manager might have primary criminal
liability where it has direct involvement
in an investee company’s activities
or operations, and where those aredetermined to be criminal under the

relevant legislation. However, Investment
Managers would not typically have thenecessary degree of direct involvement for
criminal liability.
7.3.3

As an Investment Manager would not bea member of the company, it would not
be possible for them to have secondary
liability (as described at paragraph 7.2.2
above). Liability as an as accessory istheoretically possible in very narrowcircumstances where the Investment
Manager can be demonstrated to haveaided, abetted, counselled or procured thecommission of an offence (e.g. through anominee director appointed on its behalf)
but is highly unlikely.

Civil liability
7.3.4

7.3.5

The civil liability position is similar to thatfor Asset Owners save that, to the extent
that an Investment Manager acts in an
execution-only capacity, the Investment
Manager will be further removed fromany relevant negligent conduct/conduct
in breach of the duty of care and thus lesslikely to be found liable. Under the FAIS,an Investment Manager is liable only for
its own acts and/or omissions, and would
not be liable for a breach of duty by an
Asset Owner.
It is common in almost all investment
management agreements for an Investment
Manager to seek some indemnity fromthe client for any claim made against theInvestment Manager for any loss sufferedby the client or its related parties as a resultof the Investment Manager performing
its obligations under the agreement. Any
contractual liability would be limited by
the principle of privity of contract, andan Investment Manager would typically
only owe contractual duties towards its
immediate client, the Asset Owner.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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8.

THE GROWING IMPORTANCE OF TAKING ACCOUNT OF ESG AND SUSTAINABILITY FACTORSWHERE THESE ARE ‘FINANCIALLY MATERIAL’

8.1

It has become increasingly importantfor Relevant Investors to take ESG andsustainability factors into account inmanaging portfolios because of the way inwhich they could be material to achieving
the financial investment objectives of theRelevant Investor in accordance with theirlegal duties.

8.2

Recent developments include:

8.2.1

from 2011 onwards, Regulation 28 of thePension Funds Act has required pension
funds to consider any factor, including
ESG factors, which may materially affectthe sustainable long-term performanceof an asset. It also obliges a pension fundand its board to understand the changing
risk profile of assets of the fund overtime, taking into account comprehensive
risk analysis, including but not limited tocredit, market, liquidity and operationalrisk, and currency, geographic andsovereign risk of foreign assets;

8.2.2

8.2.3

440

instruments whose risks the insurer canproperly identify, assess, monitor, manage,
control, and report on; and (b) assets
are invested in a manner appropriate to
the nature and duration of the insurer’s
liabilities and the best interests ofpolicyholders and beneficiaries.
8.2.4

8.2.5

the regulatory guidance published by
the FSCA in Guidance Notice 1 of 2019,
described at paragraph 2.2.24 above,
promoting consideration of ESG andsustainability factors and objectives bypension funds;82
for insurers, Prudential Standard GOI 3
requires an insurer’s investment policy totake into account any factor which may
materially affect the sustainable longterm performance of assets, including ESG
factors, opening greater opportunities for
insurers to engage in instrumental IFSI.
Insurers are also required to adhere to the‘Prudent Person Principle’ by establishingmeasures that will assist in ensuring that:(a) the insurer invests only in assets and

8.3

8.3.1

as of 1 July 2018, insurers became subject
to a risk-based regulatory framework
and are required to have a documented
risk management strategy which must,
among other things, describe current
material risk and emerging risk, andthe insurer’s approach to managing
those risks. Physical climate risk is dealt
with by explicitly requiring insurers to
calculate capital requirements for natural
catastrophe risk (although it is currently
only calibrated for certain types ofcatastrophes); anda four-year multi-jurisdiction project
recently carried out by UN PRI and UNEPFI, Fiduciary Duty in the 21st Century, whichconcluded that “investors that fail toincorporate ESG issues are failing theirfiduciary duties and are increasingly
likely to be subject to legal challenge”.83
The project included a consideration of
fiduciary duty in the context of retirement
funds in South Africa.84
Additional reasons for the growing
importance of Relevant Investors taking
into account ESG and sustainability factors
where they are financially material include:
growing public, policy and regulatory
expectations that they should do so(including those mentioned above), which islikely to affect the way in which legal duties
are understood and applied in practice;

8.3.2

8.3.3

8.3.4

8.3.5

international collaboration among
regulators in respect of sustainability
issues. For example, in 2017, thePrudential Authority became a memberof the Sustainable Insurance Forum, a
network of leading insurance supervisors
and regulators working together tostrengthen their understanding of, andresponses to, sustainability issues for thebusiness of insurance;85
a growing trend towards sustainabilitybased legal actions where businessenterprises and others are seen as having
contributed to sustainability challenges;
increasing stakeholder engagement andshareholder activism around sustainability
issues generally, as has been experienced
by a number of JSE-listed companies inrecent years;
greater knowledge of the risks thatsustainability factors can pose to portfolio
performance, particularly in the areaof climate change but also as a resultof the COVID-19 pandemic, and theopportunities that they can provide;

8.3.6

greater awareness of the speed withwhich some sustainability risks may bematerialising;

8.3.7

improving disclosure regimes, making it
more feasible to understand the role ofindividual business enterprises in
helping to realise or in undermining
sustainability goals;

8.3.8

growing availability of good quality
investment analysis of the risks posed
to business enterprises by sustainability
factors and potential opportunities;

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION

8.3.9

growing expertise and developing
conceptual frameworks in the areasof sustainability assessment and theinvestment management expertise needed
to take greater account of sustainability inthe investment process; and8.3.10 the development of investor alliances andcoalitions making it easier for investors toaddress sustainability risks.
8.3.11 We anticipate that Beneficiaries,
particularly institutional investors, will
increasingly expect Relevant Investors to
explain the basis on which they determine
their investment criteria, and how they
have incorporated the consideration of
ESG and sustainability factors into theirinvestment and stewardship activities.
So too will activists, NGOs and civilsociety groups, for example Centre forEnvironmental Rights,86 Raith Foundation,87
and Just Share, who use advocacy,
engagement and activism to support active
ownership and responsible investment.88

8.4

Financial materiality

8.4.1

It can be challenging for Relevant
Investors to determine which ESG or
sustainability factors are financiallymaterial to their portfolio. As Boston
Consulting Group put it recently:“

Because not every ESG factor will be material
to all businesses and sectors, it is essential
for both companies and investors to be able
to identify and manage those that are. Thatsaid, what is financially material will changeover time—and with rapidly increasing
speed. This requires the ability to understandwhat makes ESG issues become financiallymaterial over time and to adapt to thechanges. In a new age of materiality, investors
must proactively work to understand ESG
facto rs and incorporate these trends into
investment decision making in a more agileway.”89

Generally, Relevant Investors should
employ the mechanisms they would
apply to any other factor to determine
whether an ESG or sustainability factor is“financially material”.
8.4.2

We have not identified any case law on what
“financial materiality” is in this particular
context. As to guidelines, there are a numberof entities and bodies that have publishedguidance on “financial materiality” at theenterprise level which regard financiallymaterial factors as those that could have asignificant impact on a company’s businessmodel and value drivers:(a) National Treasury recently worked with
the University of Cambridge Institute of
Sustainability Leadership (CISL) Centre
441

for Sustainable Finance to promote theuse and integration of “environmental
scenario analysis as a key tool to allow
financial firms to analyse, measureand manage material sources ofenvironmental risk”;90(b) GRI and RobecoSAM, the Swiss extrafinancial rating agency, suggest thefollowing working definition of “financiallymaterial”, which is used by some investors
in South Africa: “Financially material isany factor which might have a present
or future impact on companies’ value
drivers, competitive position, and thus on
long-term shareholder value creation.”
The assessment of materiality is madefrom a Relevant Investor’s perspective,
not generally, and will differ from one
sector to another. The time frame factor ofsustainability is taken into account, mostimportantly long-term shareholder value
creation. Lastly, it focuses on a company’svalue drivers: growth, profitability, capitalefficiency and risk exposure; 91 and(c) King IV defines “material” or “materiality”
as a “measure of the estimated effect thatthe presence or absence of an item of
information or identified subject matter
may have on the accuracy or validity ofa statement or decision. Materiality is
judged in terms of its inherent nature,
impact (influence) value, use value, and thecircumstances (context) in which it occurs”.
This definition would cover financiallymaterial matters. Insofar as reportingand disclosures are concerned, King IV
describes “materiality” in relation to theinclusion of information in an integrated
report as referring to matters that “could
substantively affect the organization’s
ability to create value over the short,medium and long term”.92

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION

8.4.3

There are various other initiatives
currently underway to consider
materiality with regard to sustainability
issues. The Sustainability AccountingStandards Board, for example, is giving
a lot of attention to financially material
issues from a Sustainability Impact
perspective, with a view to helping
businesses report such matters.93(b) insurers are required to take into accountany factor, including ESG factors, which
may materially affect the sustainablelong-term performance of assets, andensure that assets are invested in amanner appropriate to the nature andduration of the insurer’s liabilities andthe best interests of policyholders andbeneficiaries; and8.5

Time period by reference to which‘materiality’ is to be assessed

8.5.1

Financial materiality should be measured
over the appropriate time-horizon,
considering the nature of the investment
and the purpose for which it is made:(c) for CISs, the period by which to assess
financial materiality is likely to be guided
by the investment period defined in the
CIS (typically three to five years for a CIS
in securities), informed by minimum
investment periods.

(a) pension funds should assess financial
materiality with reference to a long-term
period, since Regulation 28 requires thattrustees give appropriate consideration
be given to any factor, including ESG
factors, which may materially affect thesustainable long-term performance of afund’s assets. This does not mean thatshort-term and medium-term performance
may be ignored. Other Relevant Investors’
regulatory frameworks do not address
the time period with reference to whichmaterially should be determined;

8.5.2

8.5.3

Investment Managers will agree theirinvestment horizons in their IMAs with
Asset Owners and will invest with respect
to those in accordance with industry
best practice. This can cause Investment
Managers to take particularly short-term
views with respect to their portfolio
construction.
King IV takes into account short-,
medium- and long-term time horizons,
with an emphasis on the long term:“performance in terms of all-inclusive
value should be assessed over the
longer term. The capital market system
must reward long-term decisionmaking”. RobecoSAM’s definition (setout at paragraph 8.4.2(b) above) takes
into account short-term impacts but
emphasises long-term value creation.

ACKNOWLEDGEMENTS

Carmen Bradfield, David Geral, Richard Griffin,
Ryan Kitcat, Wandisile Mandlana, Deirdre
Phillips, Christine Rodrigues, Kirsten Serrurier
and Bright Tibane

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

442

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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION
1Constitution of the Republic of South Africa, 1996.

2

See Chapter 2 of the Constitution.

3

Section 8.3 of the Constitution.

4

Section 39(1).

5Section 7 of the FSRA.

6

The “governing body” means, in relation to a financial institution, aperson or body of persons, whether elected or not, that manages,
controls, formulates the policy and strategy of the financial
institution, directs its affairs or has the authority to exercise thepowers and perform the functions of the financial institution, andincludes the board of directors of a company, the board of a pension
fund, and the trustees of a trust.

7

Section 6 of the FSRA.

8

Copies of the legislation are available at: www.fsca.co.za, www.
resbank.co.za and www.treasury.gov.za.

9

10

11

12

investment advisory services, carried out a study, the results ofwhich suggested that although many asset managers claim
to endorse the CRISA there is limited analysis on how they
actually perform against the CRISA’s five principles. The Kigoda
Responsible Investment Ranking 2017 used CRISA’s five principles
and its practice recommendations to assess, publicly disclosed
information, whether 10 of South Africa’s largest asset managers
have the policy frameworks and governance structures in place toimplement sustainable and responsible investment. It also assesses
whether they adequately disclose information on their responsible
investment performance. These 10 managers account for around
two-thirds of total assets under management in South Africa byasset managers, including multi-managers.
20

On disclosure, see CRISA Practice Note: Guidance on disclosureof the application of CRISA, May 2017, available online at: https://
cdn.ymaws.com/www.iodsa.co.za/resource/collection/58CA7BC88C67-4CF7-A644-0EDB06165C8B/Guidance_on_disclosure_of_
application_of_CRISA.pdf.

Prudential standards must be aimed at one or more of the following:(i) ensuring the safety and soundness of financial institutions; (ii)reducing the risk that financial institutions and key persons engage
in conduct that amounts to, or contributes to, financial crime; and(iii) assisting in maintaining financial stability.

21

CRISA Committee, CRISA Code for Responsible Investment in South
Africa: 2020 Revision Consultation Draft, available online at: https://
cdn.ymaws.com/www.iodsa.co.za/resource/collection/1D7CF73BB95B-453F-A8E3-D19829D18FBD/CRISA_2.0_Draft_for_public_comment. November2020__00000004_.pdf.

A conduct standard must be aimed at one or more of the following:(i) ensuring the efficiency and integrity of financial markets; (ii)ensuring that financial institutions and representatives treat financial
customers fairly; (iii) ensuring that financial education programs,
or other activities promoting financial literacy are appropriate; (iv)reducing the risk that financial institutions, representatives, key
persons and contractors engage in conduct that is or contributes tofinancial crime; and (v) assisting in maintaining financial stability.

22

Accessible online at: http://www.iodsa.co.za/page/KingIVReport.
The Institute of Directors in Southern Africa NPC owns all copyrightand titles in the “King IV Report on Corporate Governance for South
Africa, 2016”. King IV™ and King IV Code™ are trademarks of the
IoDSA.

23

According to the FSCA, as at 31 March 2020 there were 1 528 active
retirement funds registered with the FSCA. FSCA Annual Report
2019-20, available online at: https://www.fsca.co.za/Annual%20
Reports/FSCA%20Annual%20Report%202019-2020.pdf.

24

Section 4 of the Pension Funds Act.

25

A retirement fund can sue its board members and/or service
providers (including Investment Consultants and Investment
Managers) for wrongful losses occasioned to the fund.

26

Section 5 of the Pension Funds Act.

27

Section 7C of the Pension Funds Act. In addition to the duties under
the Pension Funds Act, a pension fund’s board is subject to fiduciary
duties at common law. Common law duties that apply to retirement
funds include the duty to act with due care, diligence and goodfaith, avoid conflicts of interest and to act with impartiality.

The Working Group consisted of representatives of: South African
Reserve Bank, Financial Sector Conduct Authority (FSCA), Prudential
Authority (PA), Department of Environment Affairs (DEA), The South
African Insurance Association (SAIA), The Banking Association ofSouth Africa (BASA), The Association for Saving and Investment
South Africa (ASISA), The Johannesburg Stock Exchange (JSE),
Batseta – Council for Retirement Funds of South Africa.
National Treasury, Draft Technical Paper 2020: Financing a
Sustainable Economy, available online at: http://www.treasury.gov.za/
publications/other/Sustainability%20technical%20paper%202020.
pdf.

13

Sustainable Finance Paper, at page 11.

14

Sustainable Finance Paper, at page 5.

28

15

Sustainable Finance Paper, at page 18.

29

Section 13 of the Pension Funds Act.

16

Sustainable Finance Paper, at page 38.

30

17

See Taxonomy Working Group, Working Draft: Draft Green FinanceTaxonomy, June 2021, Version 1.5, available online at: https://sustainablefinanceinitiative.org.za/wp-content/uploads/2021/06/
Draft-Green-Finance-Taxonomy.pdf (accessed 2 July 2021).

Sasol Limited & others v Chemical Industries National Provident
Fund [2015] JOL 33910 (SCA) at para [13].

31

Tek Corporation Provident Fund and Others v Lorentz [1999] 4
All SA 297 (A) (3 September 1999). The board may, by way of aresolution, amend the rules in accordance with the Pension Funds
Act and the fund’s rules. A fund may, in the manner directed by its
rules, alter or rescind any rule or make any additional rule subject
to approval by the FSCA. If the FSCA finds that the amendment
is consistent with the Pension Funds Act, and is satisfied that it isfinancially sound, the FSCA must register the amendment.

18

19

443

CRISA is available online at: www.iodsa.co.za/page/CRISACode.
CRISA has been endorsed by the Institute of Directors in Southern
Africa (IoDSA), the Principal Officers Association (POA), and the
Association for Savings and Investment South Africa (ASISA).
The principles of CRISA are supported by the FSCA and theJohannesburg Stock Exchange (JSE). Many Asset Owners (including
those who are members of ASISA and adhere to CRISA by virtue ofthat membership) and Investment Managers support the principles
espoused by CRISA, and incorporate them into their responsible
investment policies. There is no signatory mechanism for CRISA.
There is a wide variation in the quality of annual disclosures
regarding the implementation of responsible investment practices.
In 2017 Kigoda Consulting, a consultancy offering responsible

Section 7D of the Pension Funds Act.

32

The principles are in Regulation 28(2)(c) of the Pension Funds Act.

33

Regulation 28(2)(c)(ix).

34

B-BBEE is a central part of the South African government’s economictransformation strategy. The key legislation in this regard is the
Broad Based Black Economic Empowerment Act, 1998 (BEE Act)and the Codes of Good Practice published in terms thereof (Codes).
The Codes set out certain targets in relation to the various elementsof B-BBEE – black equity ownership, management, employment
equity, enterprise development, preferential procurement, skills
development and socio-economic development initiatives – against
which companies’ South African operations are measured. There are
generic Codes and sector-specific Codes. For example, the financial
sector code applies to banking, long and short-term insurance, themanagement of collective investment scheme assets as well as asset
management, consulting and administration (amongst others)
A measured entity’s contribution to black economic empowerment
is assessed against a B-BBEE scorecard, with its overall score thentranslating to a B-BBEE rating, with Level 8 being the lowest ratingand Level 1 being the highest (and best) rating that can be achieved
In terms of the BEE Act, every organ of state and public entity inSouth Africa is legally bound to take into account and, as far as isreasonably possible, to apply the Codes in, amongst other things,
determining criteria for the issuing of licences and developing a
procurement policy for selecting their service providers. For example
a state owned company’s procurement policy may require that its
suppliers achieve at least a Level 4 B-BBEE rating.
Other than in certain state licensing, permitting and authorisation
processes, there is no “hard law” requiring that any private entity inSouth Africa must meet specific B-BBEE targets or must implement
a B-BBEE policy. The BEE Act does not provide for offences or
penalties relating to B-BBEE performance but rather seeks, throughthe economic measures discussed below, to facilitate a uniform
approach to B-BBEE in the South African economy. However,from a commercial perspective, although there are no absolute
requirements in relation to achieving specific B-BBEE targets, any
company wishing to do business in South Africa must consider
and develop its B-BBEE position. This is because, in addition to thepressures from government, an entity which does not have a good
B-BBEE rating or which fails to take steps to improve its B-BBEE
rating may be hampered in the conduct of its day-to-day businesswith government, organs of state and private sector customers.
35

This means that the adoption of an investment policy would beprocedurally defective if the Minister (or his or her delegate) has
not been included in the relevant deliberations preceding such
adoption, notwithstanding that the Minister is not empowered todetermine (or reject) the investment policy except on prescribedgrounds.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

36

See https://www.gepf.gov.za/gepf-law-and-rule/.

European Union

37

The GEPF IPS is available at: https://www.gepf.gov.za/wp-content/
uploads/2020/11/INV-C-0002112.pdf.

France38

The deed of a CIS is the agreement or document that regulates
establishment, administration and management of the scheme.

Japan

39

An open-ended investment company is a company with anauthorised share capital, which is structured in such a manner thatit provides for the issuing of different classes of shares to investors,
each class of share representing a separate portfolio with a distinct
investment policy.

Netherlands

40

Section 62 of CISCA.

41

Section 65 of CISCA.

42

Yarram CC t/a Tijuana Spur vs Absa Bank Ltd, 2007 (2) SA 570(SCA).

43

CISCA defines “assets” as “investments comprising or constituting
a portfolio of a CIS and includes any income accruals derived or
resulting from the investments in the portfolio which are held for orare due to the investors in that portfolio”.

44

Section 4 of CISCA.

45

Section 2 of CISCA.

South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

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SOUTH AFRICACONTENTSFOREWORDSINTRODUCTION
46

A “nominee company” is controlled by a financial institution,
which: (i) is incorporated under the provisions of the Companies
Act; (ii) has as a special condition contemplated in section 15(2)of the Companies Act the requirement to act as nominee for, or
representative of, any person in the holding of any property in trust
for such person or persons; (iii) is precluded as a special condition inits Memorandum of Incorporation from incurring any liabilities otherthan to the persons on whose behalf it holds assets, to the extent
of their respective rights to, and interest in, such assets; and (iv)
has entered into an irrevocable written agreement with a financial
institution which controls the company, and in terms of whichsuch financial institution has undertaken to pay all the expenses
of, and incidental to, its formation, operations and liquidation. The
obligations also extend to a director, member, partner, official,
employee or agent of a nominee company.

47

Section 2 of the FIA.

48

Section 97 of CISCA.

49

Section 85 of CISCA.

50

The FSCA in Board Notice 90 of 2014, determined the securities,classes of securities, assets or classes of assets that may be included
in a portfolio of a CIS in securities, as well as the manner in which,limits and conditions to which such securities or assets are subject.
General Notice 572 of 2008 and Board Notice 126 of 2013 provides
for investment limits/restrictions for CISs in property. Board Notice
65 of 2014 provides for investment limits/restrictions for CISs inparticipation bonds. Board Notice 52 of 2015 provides for investment
limits/restrictions for CISs in hedge funds

51

Section 5(4) of the Insurance Act.

52

Section 4 of the Insurance Act.

53

Section 36 of the Insurance Act. Ultimate responsibility for theprudent management of the financial soundness of an insurer, rests
with the insurer’s board of directors. The board of directors musthave in place procedures to monitor the financial soundness of an
insurer and to identify any deterioration in its actual or expected
capital resources or business conditions. The Prudential Authority
notes that prudent investment management extends beyond
meeting the regulatory minimum financial soundness requirements.

54
55

56
57

444

A policyholder is the holder of a life insurance policy or a non-life
insurance policy, or his or her successor in title.
Section 30(1) of the Insurance Act. The governance framework
must: (i) be proportionate to the nature, scale and complexity of theinsurance business and the risks of the insurer, or the business andrisks of the insurance group; (ii) include effective systems of corporate
governance, risk management and internal controls; and (iii) address,
and provide for, the matters prescribed under the Insurance Act.
See section 76 of the Companies Act, and the common law fiduciary
duties owed by a director to a company.
Section 76(4)(a). This statement assumes the director’s decision is
not tainted by a conflict of interest. It is an additional requirement ofsection 76(4)(a) that the director’s decision must not be tainted by a
conflict of interest (the obligations on directors in respect of personal
financial interests in matters/decisions are set out in section 75 of
the Companies Act).
The Companies Act states only that a director must take reasonably
diligent steps to become informed about the matter, and is entitled(in making an informed decision) to rely upon: the performanceof: any employee whom the director reasonably believes to bereliable and competent in the functions performed or information
provided; legal counsel, accountants or other professional advisors
retained by the company, the board or a committee as to matterswhich the director reasonably believes are within that person’s
expert/professional competence, or as to which that person merits
confidence; a committee of the board of which the director is not amember, unless the director has reason to believe that the actionsof the committee do not merit confidence; or any person to whom
the board may reasonably have delegated, formally or informally bycourse of conduct, the authority or duty to perform one or more of
the board’s functions that are delegable under applicable law; andany information, reports, opinions, recommendations, reports orstatements (including financial statements and other data) preparedor presented by any of those persons.
58

Prudential Standard GOI 2: Governance of Insurers, available online
at: https://www.masthead.co.za/wp-content/uploads/2019/01/
Prudential-Standard-GOI-2-Governance-of-Insurers.pdf.

59

Section 39 of the Insurance Act provides that in circumstanceswhere an insurer has failed to maintain a financially sound condition,
the Prudential Authority may restrict or prohibit certain activities ortransactions of an insurer, controlling company or insurance groupuntil the capital requirements are complied with and the financial
soundness of the insurer or insurance group has been restored.

60

CISL ClimateWise Principles accessible online at: www.cisl.cam.
ac.uk/business-action/sustainable-finance/climatewise/images/
climatewise-principles.png/view.

61

Sanlam and Santam’s ClimateWise reports are available online
at: https://www.sanlam.com/investorrelations/downloadscentre/
Documents/Sustainability%20reports/Sanlam_ClimateWise_
Report_2020.pdf and https://www.santam.co.za/products/
climatewise-report/, respectively.

62

For further details on these funds see: https://climatefundmanagers.
com/funds/; https://www.santam.co.za/media/2416227/resiliant_fund.
pdf; and https://www.sanlam.co.za/campaigns/financialresilience/
Documents/Darryl_Moodley_August.pdf.

63developed and more uncertain – nonetheless, they could have ameaningful impact on the PA’s objectives over time.”
64

The CRISA Committee has published a model mandate, which isinformed by the ICGN Model Mandate, to be used between Asset
Owners and Investment Managers in the South African context,
available online at: https://cdn.ymaws.com/www.iodsa.co.za/resource/collection/2BB91484-C408-4372-A045-FAF4E98560F5/Position_
Paper__Model_Mandate.pdf.

65

See, for example, UN-PRI Guide to Collaborative Engagement,
available online at: https://www.unpri.org/download?ac=4156.

66

For example, the ICGN Global Stewardship Principles,available online at: https://www.icgn.org/sites/default/files/
ICGNGlobalStewardshipPrinciples.pdf.

67

See the UN-PRI commissioned guidance on collaborative
engagement and acting in concert, available online at: https://www.
unpri.org/addressing-system-barriers/6270.article and https://www.
unpri.org/pri-podcasts/acting-in-concert-in-south-africa/5857.article.
In 2010, the Takeover Regulation Panel reviewed a guide publishedby UN-PRI with regard to collaborative engagement in the context ofPrinciples 2 and 5 of the PRI, available online at: https://cdn.ymaws.
com/www.iodsa.co.za/resource/collection/58CA7BC8-8C67-4CF7A644-0EDB06165C8B/2013.05.14_PRI_Collaborative_Engagement_
Guidance.pdf.

68

Section 123 of the Companies Act.

69

Section 56 and section 122 of the Companies Act.

70

See Chapter X of the FMA. There are three broad categories of insider
trading offences under the FMA, each of which a Relevant Investor
would have to bear in mind:

For example, the Sustainable Finance Paper (at paragraph 10.7.1,
page 46) refers to the following climate related risks as presenting
substantial challenges to the business model of insurers:“The ways in which the insurance sector, and hence the PA’s
objectives, could be impacted by climate change are diverse,
complex and uncertain. The primary channels (‘risk factors’) throughwhich such impacts might be expected to arise are:Dealing offences: First, when an insider, who knows they have inside
information relating to securities listed on a regulated market,
deals (whether directly or indirectly or through an agent) in thosesecurities to benefit himself or herself, or to benefit another person.
Second, when any person, who knows that an insider possesses
inside information, deals (whether directly or indirectly or throughan agent) for the insider in listed securities in respect of which theinsider possesses inside information.

Physical risks: the first-order risks, which arise from weather-related
events, such as floods and storms. They comprise impacts directly
resulting from such events, such as damage to property and thosethat may arise indirectly through subsequent events, such as
disruption of global supply chains or resource scarcity.
Transition risks: the financial risks, which could arise for insurance
firms from the transition to a low-carbon economy. These can comeabout through changes in regulation, changes in technology or
consumer pressure. For insurance firms, this risk factor is mainly
about the potential re-pricing of carbon-intensive financial assets,
and the speed at which any such re-pricing might occur. There ispotential for rising costs, and therefore decreasing affordability, of
insurance premiums given the increase in risks. To a lesser extent,
insurers may also need to adapt to potential impacts on the liability
side resulting from reductions in insurance premiums in carbonintensive sectors.
Liability risks: risks that could arise for insurance firms from parties
who have suffered loss and damage from climate change, and thenseek to recover losses from others who they believe may have been
responsible. Where such claims are successful, those parties against
whom the claims are made may seek to pass on some or all of thecost to insurance firms under third-party liability contracts such asprofessional indemnity or directors’ and officers’ insurance.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

Disclosure offences: When an insider, in the knowledge that they
have inside information, discloses such inside information.

European Union

Influencing offence: When an insider, in the knowledge that he or
she has inside information encourages or causes another person todeal, or discourages or stops another person from dealing, in listed
securities which are likely to be affected by inside information. There
are limited exceptions to each of the above offences, which we do
not go into in this annex.

France71

Competition rules are contained primarily in the Competition Act,
1998.

72

There is no case law in South Africa dealing specifically with thesecategories of conduct, or the sustainability context in particular, but
the general principle in section 4(1)(a) of the Competition Act is thatcollaboration between competitors which does not amount to pricefixing, market allocation or collusive tendering is allowed as long as it
does not harm competition (or if it does, this effect is outweighed byits pro-competitive, efficiency or technological benefits).

73

Paragraph 4.1 of Guidance Notice 1 of 2019.

74

Sustainable Finance Paper, page 35.

Japan

Netherlands
South Africa

United Kingdom
United States

GLOSSARY
REFERENCES

Infrastructure risks: For each of these risk factors, it is vital to explore
the nature of the risk, the possible impacts on the liability and/or asset sides of insurance firms’ balance sheets, and the actions
firms are taking to mitigate them. The clearest risk is from the firstcategory – physical risks. The other two risk categories are less well

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75

Section 13(2) of the FAIS. The FAIS prescribes that a code of
conduct must ensure that the clients will be able to make informed
decisions, and that their reasonable financial needs regarding
financial products will be appropriately and suitably satisfied. Two
key codes have been published under FAIS: (i) the Code of Conduct
for Administrative and Discretionary FSPs, 2003 (DiscretionaryCode); and (ii) the General Code of Conduct for Authorised Financial
Services Providers and Representatives, 2003.
The Discretionary Code draws a distinction between administrative
FSPs and discretionary FSPs: (1) An administrative FSP is a FSP,
other than a discretionary FSP, that renders intermediary services inrespect of various financial products on the instructions of a client
or another FSP through bulking. Bulking is the aggregation by anadministrative FSP of: (a) clients’ funds when buying or investingin financial products on behalf of clients, and the subsequent
allocation of such financial products to each client separately inthe records of the FSP; (b) the financial products belonging toclients when selling such financial products on their behalf, andthe subsequent allocation of the proceeds of such sale to eachclient separately in the records of the FSP. (2) A discretionary
FSP is one that renders intermediary (financial) services of adiscretionary nature as regards the choice of a particular financial
product, but without implementing any bulking. Whether an
Investment Manager is an administrative or a discretionary FSP
will depend on whether its mandate is discretionary in nature(which is generally typical for Investment Managers’ and FiduciaryManagers’ Mandates) and whether any bulking, as described (whichis less typical of Investment Managers’ and Fiduciary Managers’
mandates), is intended to be implemented. Both administrative
FSPs and discretionary FSPs act in accordance with the Discretionary
Code, the General Code, FAIS and applicable laws, and invest inaccordance with mandates concluded with their clients.
The Discretionary Code prescribes that a discretionary FSP must:(i) provide to the client (Asset Owner), on request, any reasonable
information regarding the financial products of the client,market practices and the risks inherent in the different markets
and products; and (ii) before entering into a mandate with theclient: obtain information with regard to the client’s financial
circumstances, needs and objectives and such information that isnecessary to enable the FSP to render suitable intermediary services
to the client; identify the financial products that best suit the client’s
objectives, risk profile and needs, subject to the limitations andrestrictions imposed on the FSP by its licence.
The FSP must obtain a signed mandate before rendering any
intermediary services to that client. The mandate records thearrangements made between a client and a discretionary FSP
and must, among other things: authorise the discretionary FSP to
act on behalf of the client, indicating whether the authorisation is
given with full or specified limited discretion; state the investment
objectives of the client and whether there are any investment or
jurisdiction restrictions that apply to the rendering of intermediaryservices in relation to the financial products involved.

76

CRISA, principle 1.

77

Section 3 of the General Code.

78

Criminal liability is provided for in: Section 49 of the National
Environmental Management Act, 1998; Section 151(1) of the
National Water Act, 1998; sections 51 and 52 of the National
Environmental Management: Air Quality Act, 2004; section 67 of
the Hazardous Substances Act, 1973; and the Asbestos Prohibition
Regulations.

79

Section 28 of NEMA.

80

Section 32 of NEMA provides for locus standi in respect of any
breach or threatened breach of any statutory provision concernedwith the protection of the environment or the use of natural
resources.

81

445

See, for example, Centre for Environmental Rights (https://cer.org.za/

programmes/corporate-accountability); Just Share (https://justshare.
org.za/about/what-we-do); and The Raith Foundation (https://www.
raith.org.za/index.php/responsible-investment).
82

See Intellidex (Pty) Ltd Research Report August 2020 ‘Investing for
Impact: Pension funds portfolio strategies’, available online at: https://www.intellidex.co.za/reports/investing-for-impact-report/.

83

UN-PRI and UNEP FI, Final Report: Fiduciary Duty in the
21st Century, available online at: https://www.unpri.org/
download?ac=9792. Also see: https://www.unpri.org/fiduciary-duty/
fiduciary-duty-in-the-21st-century/244.article. See Fasken opinion‘The duty of a board of a pension fund to take climate change
into account when making investment decisions’ 4 April 2019,addressed to Just Share NPC and ClientEarth, available online at:https://justshare.org.za/wp-content/uploads/2019/04/2019_Pensionfund-legal-opinion-by-Fasken.pdf. Also see M Isa ‘Ignore sustainable
investment at your own peril’ FinWeek 6 November 2019, available
online at: https://www.fin24.com/Finweek/Investment/ignoresustainable-investment-at-your-own-peril-20191105.

84

https://www.genfound.org/media/1433/fiduciary-duty-in-the-21stcentury-sa-roadmap.pdf.

85

SIF has recognised climate change as a significant risk on humanand environmental systems, including an increasing frequency
and severity of natural catastrophes. The SIF’s objective is toraise awareness for insurers and supervisors of the challenges
presented by climate change, including current and contemplated
supervisory approaches for addressing these risks. Climate change
risk is recognised by the Prudential Authority although insurance
regulation has not formalised and explicitly included climate risk inall parts of its legislative and supervisory frameworks. South Africa’s
inclusion as a member affords the country valuable insights into
global insurance initiatives, critical in an emerging market anddeveloping economy like South Africa. The learnings since assuming
membership in SIF has been exponential for South Africa as it
continues to refine and enhance its insurance regulatory framework.
South Africa has seen an increase in natural catastrophes (droughts,
floods and hailstorms) over the past few years. Apart from theincrease in physical climate risk, there is also an increasing risk
associated with the transition to a low-carbon economy.

86

See https://cer.org.za/programmes/corporate-accountability.

87

See https://www.raith.org.za/index.php/responsible-investment.

88

See https://justshare.org.za/about/what-we-do.

89

Boston Consulting Group ‘Unlocking Tomorrow’s ESG Opportunities’at https://www.bcg.com/en-za/publications/2020/future-esgenvironmental-social-governance-opportunities. See also: World
Economic Forum White Paper ‘Embracing the New Age ofMateriality: Harnessing the Pace of Change in ESG’ in collaboration
with Boston Consulting Group, available online at: http://
www3.weforum.org/docs/WEF_Embracing_the_New_Age_of_Materiality_2020.pdf.

90University of Cambridge Institute for Sustainability Leadership (CISL)(2018). Embedding environmental scenario analysis into routine
financial decision-making in South Africa, UK: the Cambridge
Institute for Sustainability Leadership, available online at: https://www.cisl.cam.ac.uk/resources/publication-pdfs/embeddingenvironmental-scenario-analysis-into-financial-decision-making-insouth-africa.

91

See RobecoSAM and Global Reporting Initiative ‘Defining Materiality:
What Matters to Reporters and Investors’, available online at: https://www.globalreporting.org/resourcelibrary/Defining-Materiality-WhatMatters-to-Reporters-and-Investors.pdf

92

Definition of “materiality” taken from the International Integrated
Reporting Council, The International <IR> Framework (13 December2013), p 5, available online at http://integratedreporting.org/resource/

internationalirframework/.
Sustainability Accounting Standards Board: https://www.sasb.org/
standards-overview/materiality-map/.
93

Also see: The IFC Beyond the Balance Sheet: IFC Toolkit forDisclosure and Transparency: https://www.ifc.org/wps/wcm/
connect/d4bd76ad-ea04-4583-a54f-371b1a7e5cd0/Beyond_
The_Balance_Sheet_IFC_Toolkit_for_Disclosure_Transparency.
pdf?MOD=AJPERES&CVID=morp0vo;
https://www.accountability.org/wp-content/uploads/2017/02/
Redefining-Materiality-2.pdf; https://www.unepfi.org/news/themes/
ecosystems/groundbreaking-new-tool-enables-financial-institutionsto-see-their-exposure-to-natural-capital-risk/.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands
South Africa

United Kingdom
United States

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REFERENCES

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1.

INTRODUCTION

1.1

This Annex considers the extent to which
IFSI is required, or may be permitted,
under the laws of England and Wales as at
31 January 20211, including relevant EU
legislation in force or implemented prior
to that date2. As the UK has left the EU, it
is not obliged to implement EU legislation
with an end implementation date later
than 31 December 2020.

1.2

1.3

1.4

446

Terms defined in the Report Glossary
apply in this Annex, as do the additionalterms defined in its own glossary locatedat Appendix 1 to this Annex. The terms
Asset Owner and Beneficiary are examined
in detail at Appendix 1 to this Annex,
which also identifies the investment
decision-maker in relation to each of theAsset Owners covered in this Annex.
The expression “IFSI” is explainedin Part 1A of the Report. Currently,
the most widely discussed example
of a sustainability factor is climatechange.3 This may well be because it isgenerally perceived as the most urgent
sustainability risk.4 For this reason,
most of the examples included in thisAnnex are climate change-related. Theynevertheless provide helpful guidance
as to how Asset Owners could approachother sustainability factors, for example,
water usage, biodiversity loss5 andwidespread antibiotic resistance.
In seeking to influence the activities of
portfolio companies or regulatory or
relevant government policy, Asset Owners
and their Investment Managers have threeprincipal tools to deploy - their powers
of investment and disinvestment, theirpowers of stewardship6 and public policy
engagement. Once an Asset Owner has
decided that a particular sustainability

ACKNOWLEDGEMENTS

factor presents a material financial risk
to its investment goal or an investment
objective,7 it will then need to decide
which (if any) of these tools to deploy toaddress that risk and whether to wield
that tool itself or to ask its Investment
Manager or another agent8 to do so. This
will include consideration of whether the
chosen tool is most effectively deployed ona solo or collective basis.9
1.5

1.6

1.7

1.9

This Annex deals primarily with situations
where an Asset Owner is not obliged topursue an express sustainability factorrelated investment goal or objective (bycontrast with, for example, a mutualfund specifically established with asustainability-related objective as well as afinancial return objective).
As noted at Part A.3.2.2 of the Report
different Asset Owners will adopt different
investment strategies. This Annex
comments where differences potentiallyarise between passive (or index-tracking)and active strategies.
The precise circumstances surrounding
each Asset Owner or Investment
Manager are critical to its investmentrelated decisions (i.e. those concerninginvestment, holding or disinvestment,
stewardship or public policy engagement- the expression is used in this Annex
as a convenient shorthand to cover all
three). This Annex seeks to summarise theframework of legal and regulatory issues
within which those decisions should be
made, but it is no substitute for legal
advice in individual circumstances.

Legal context and market practice relating toinvestment decisions
1.8

intricate web of law, regulation, guidance
and regulatory expectation, together
with contractual or trust-based rights
for some Beneficiaries and expectations
based on marketing material, surrounds
investment-related decision-making by the
Asset Owners considered in this report,
especially decisions relating to investment
and stewardship.

As noted at Part B.3 of the Report, an

1.10

It is also usual for Asset Owners to appoint
one or more Investment Managers tomanage their assets on a discretionary
basis.10 Investment Managers’ investment
and stewardship decisions on behalf ofclients and public policy engagement
are similarly shaped by law, regulation,
guidance and regulatory expectation andby the agreements made with the Asset
Owners for whom they act. All this adds
further layers of complexity. These arepotentially compounded when the Asset
Owner is established in one jurisdiction
and the Investment Manager in another.11
Delegation also means that theinvestment-related decisions made by
an Asset Owner are, in the main, at a
strategic (rather than investment-byinvestment) level. It will not decide
which equity or fixed income investment
to buy or (generally) how to exercise
stewardship powers and rights, but it will
set an investment and risk framework.12
This is the background against which
it will determine its investment goals,
its strategic asset allocation and its
investment strategy. These, in turn,underlie the detailed investment objective
and investment policy it sets for each ofits Investment Managers, together withany other investment-related terms of
the arrangements between them13 andEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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what it will expect reports and review
meetings to cover. These decisions are
not static ones; the Asset Owner willkeep all of these matters under review atappropriate intervals and will monitor
the activities of its Investment Manager.
In this Annex, in relation to an Asset
Owner which delegates management,
the term “investment-related decision”
is used to describe these high-level andstrategic decisions. A further detail to noteis that, for a Mutual Fund, it is the AFM(rather than the Asset Owner) which is theinvestment decision-maker and references
to “Asset Owner” in the remainder ofthis section should accordingly be read,in relation to a Mutual Fund, as if they
included the fund’s AFM.
The Stewardship Code14
1.11

1.12

447

The UK Stewardship Code is publishedby the FRC, the UK’s regulator of audit
and corporate governance standards. It
is aimed at both Investment Managers
and Asset Owners and is also applicable
to service providers which do not directly
manage investments but provide otherservices that enable clients to deliver
stewardship (for example, investment
consultants, proxy advisors and data andresearch providers). The first sentence ofthe code explains that “stewardship” isthe responsible allocation, management
and oversight of capital to create longterm value for clients and beneficiaries
leading to sustainable benefits for the
economy, the environment and society.
The Stewardship Code is not legallybinding; institutional investors and otherrelevant bodies can choose whether toapply to become signatories.15 For those
who do, the code comprises a set of “apply
and explain” principles. Signatories

are required to report annually on theactivities they have undertaken andthe outcomes they have achieved inrelation to the code’s principles, which
may require disclosure of backgroundinformation or policies in order to explain
their approach. The Stewardship Code isnevertheless legally significant in several
ways:(a) it is designed to promote good investmentrelated practices among institutional
investors. Although, on the face of it, thecode is about disclosure, in order to makethe relevant disclosures, a signatory needs
to consider, and address any issues with,
its governance structure and relevant
policies and procedures and identify,
assess and manage any relevant risks;(b) it is relevant to market practice standards(which are in turn relevant to, forexample, duty of care (see 1.57 below);(c) regulators may well take into accountstandards set by the code in applying
their rules and also take an interest in theannual reports published by Asset Owners
or Investment Managers; and(d) it contributes to the transparencyof signatories’ investment-related
decision-making and outcomes andthus to beneficiaries’ information and
expectations.
Most Asset Owners, and all Investment
Managers, covered in this Annex are, at aminimum, encourage d by their regulators
to become signatories and some are, in
effect, required by FCA rules to do so.
1.13

Under the Stewardship Code, signatories
should:(a) explain the organisation’s purposeand outline its culture, strategy andinvestment beliefs and actions taken

to ensure that these enable effective
stewardship. They should disclose how
their purpose and investment beliefs haveguided their stewardship, investment
strategy and decision-making and include
an assessment of how effective they havebeen in serving the best interests of clientsand beneficiaries (Principle 1);(b) identify and respond to market-wide andsystemic risks, including explaining how
they have aligned investments and anycollective action and relevant industry
initiatives they have participated in(Principle 4);(c) disclose the issues (including ESG issuesof importance to them) they haveprioritised for assessing investments
prior to purchase, monitoring duringholding and disinvesting, including how
this has differed for funds, asset classes
and geographies. They should explain
how information gathered throughstewardship has informed acquisition,
monitoring and exit decisions, withreference to how those decisions have best
served clients or beneficiaries (Principle7); and(d) if they appoint an Investment Manager,
explain how that manager has beenmonitored to ensure that the signatory’s
assets are managed in alignment with
their investment and stewardship strategy
and policies (Principle 8).
1.14“Investing with Purpose”, the recently
published report of the Stewardshipand Stakeholder Working Parties of the
UK Asset Management Taskforce,16 is
subtitled “placing stewardship at theheart of sustainable growth”. It includes
twenty recommendations designed to
improve stewardship still further in theUK, in large measure focused around

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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the Stewardship Code and financial
and narrative disclosure by portfolio
companies.

is a fiduciary” and “what is a fiduciaryduty” are not straightforward. Not all of
the Asset Owners covered in this Annex
owe fiduciary duties to those we haveidentified as Beneficiaries. In the relevant
parts of section 2 below, we identify whichis (or arguably is) a fiduciary and which is
not and to whom those duties are owed.
Although there is no express authority on
this point, it is generally accepted that an
Investment Manager owes fiduciary duties
to its client Asset Owners, which (as notedin 6.2(c) below), it may seek to modify or
exclude in its agreement with an Asset
Owner.20

Importance of industry guidance
1.15

A court which is asked to consider
whether an Asset Owner or Investment
Manager has fulfilled applicablerequirements will want to consider any
pertinent official or regulatory guidance
related to investment-related decisionmaking and, in some cases, may berequired to do so.17 As regards regulatory
enforcement action, a regulator is likely
to be keenly interested in whether suchguidance has been followed. Especially in
relation to climate change, the regulators
are promoting initiatives which areindustry-led and are designed to share andpromote good practice in the industries
they regulate - for example, the DWP’spublication of the PCRIG Guide 2020 and
the PRA and FCA’s joint establishment of
the CFRF (membership of which includes
insurers and investment managers) andpublication of its 2020 guide.18

1.18

1.19

Judge-made law
1.16

The law covered below may be primary(e.g. the FSMA) or delegated (e.g. the LGPS
Investment Regulations or rules made by
the PRA or FCA19) or it may be judge-made.
As far as judge-made law is concerned,
there are some broad principles ofgeneral application to Asset Owners
and Investment Managers. As regards
insurers, the FCA rules discussed in thissection apply to them but otherwise theseprinciples take the form of similar, but not
identical, statute-based directors’ duties,
which are covered in 2.4 below.

Fiduciary duties
1.17
448

The answer to the legal questions of “who

1.20

1.21

the requirement to “manage conflicts ofinterest fairly, both between itself andits customers and between a customer
and another client”.24 This requirement
also applies to an Investment Manager.
The consequences of a breach of thisrequirement are potentially different
from a breach of fiduciary duties, but thecontent is broadly similar.25
1.22

In relation to each Asset Owner, therelevant part of section 2 identifies
whether, and by and to whom, fiduciary
duties are owed.
The term “fiduciary duty” is used in thisAnnex in the strict sense of duties which
are peculiar to a fiduciary; the key duty inthe current context is the duty of loyalty.21
The primary relevance of this duty in thisAnnex is the “no conflict rule”; a fiduciarymust avoid any unauthorised conflict
between its duty and its interest and any
unauthorised conflict between duties it
owes to different beneficiaries.
The Law Commission’s summary of the2014 Report contains the important
reminder (emphasis added) that “fiduciary
duties focus on what a fiduciary should
not do, rather than what they should do.
Positive duties derive from other sources,
such as duties connected to the exercise
of a power (see 1.25 to 1.42 below) andduties of care (see 1.43 to 1.58 below).”22
Fiduciary duties support, and are mouldedby, other duties.23
An Asset Owner regulated by the FCA,
whether or not a fiduciary, is subject to1.23

Those Asset Owners and Investment
Managers who are signatories to the
Stewardship Code, should disclose theirconflicts policy under its Principle 3
and how that policy has been applied
to stewardship, including how conflicts
have been identified, managed andaddressed. The Stewardship Code gives as
examples, conflicts that arise as a resultof differences between the stewardshippolicies of Investment Managers andtheir clients, differing bond and equity
managers’ objectives within the sameorganisation and client or beneficiaryinterests diverging from each other.
These conflict descriptions mainly focus
on the position of Investment Managers.
However, the conflicts faced by many
Asset Owners are at least as acute.
Consider, for example, the position ofa pension scheme, with pensions inpayment, but also with members whowill not receive a pension for 40 or more
years. An insurer’s position is potentiallysimilar, with policies already in payment
or maturing in the short-term and policies
under which payments will not be due for
decades. Those with long-term interests
are keenly interested in steady longterm growth (whether contributed byincreasing market value or accumulated
income or a mixture of both) and thosewith shorter-term interests are interested

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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in the security of the often fixed payments
due to them. Such conflicts must be
addressed and resolved not only in
relation to strategic asset allocation andinvestment decisions, but also in relation
to stewardship and public engagement
policy-related decisions because theanticipated benefit of those decisions may
well not accrue to the same Beneficiaries
as will bear any direct and indirect26 costsof actions taken now. In practice, theseconflicts may be less acute than might
immediately appear as the interests of
those members or policyholders withshorter-term horizons may, in fact, be
provided for by investment wholly, or to agreater extent in fixed income (although
see 1.22 above for the possibility ofconflict here). Further, the board of theportfolio company itself is first in line
in seeking to balance the interests of its
current and future shareholders and will
resist stewardship efforts that it considers
do not strike this balance appropriately.
Sustainability risks may, in any event, also
crystallise in the short-term, or earlier
than expected27: “If poorly managed, [thephysical and transition risks related toclimate change] could be the source ofconsumer harm and potentially a futurefinancial crisis stemming from financial
losses and sudden adjustments in asset
values. Covid-19 has demonstrated
more than ever the need for firms to beprepared for the rapid crystallisation of
global risks”.28 Addressing and resolving
conflicts fairly (as required by the duties
outlined here and 1.43 below) are among
the key issues that will underlie an Asset
Owner’s investment-related decisions inpractice.
1.24
449

The considerable uncertainties
surrounding sustainability risks, including

the timing of impact, mean these arecomplex decisions.

generated considerable controversy”. The
Law Commission goes on to say that it
considers the “best interests” requirement
to be a “short-hand” reference to a“bundle” of more specific duties that
apply to trustees in relation in the exerciseof their powers.33

Duties connected to the exercise of a power
1.25

1.26

The 2014 Report identifies duties
which have been developed to guideand constrain the exercise of fiduciary
powers.29 We consider that they broadly
apply to the investment and stewardship
powers of both Asset Owners andInvestment Managers, although theposition of insurers is somewhat different(as explained in sections 2.4 and 3.4
below). Some of these duties are more
relevant in the current context thanothers.

1.29

Purpose-related requirements - these requirea person to:(a) act within the scope of a power - in otherwords, observe any conditions or
restrictions placed on its exercise; and(b) exercise a power for the purpose for which it isconferred - in context, it would be wrong
for a person who has been given a power
to invest solely for financial return toexercise that power in a way that is
intended to achieve some other purpose.30
1.27

1.28

By long-standing convention, trustees andothers exercising a fiduciary power havetended to be described as being subject
to a duty to act in the “best interests” oftheir beneficiaries when exercising theirpowers and discretions and this has often
been perceived as a distinct legal duty.
The 2014 Report31 notes “this phrase
appears in the case law, in the [Private
Scheme] Investment Regulations and in
the IORP II. However, it has no statutory
definition. Its meaning is discussed ina small number of cases, of which themost significant is Cowan v Scargill32…aparticularly difficult case which has

1.30

More recent case law has confirmed this.
In Re Merchant Navy Ratings Pension Fund;
Merchant Navy Ratings Pension Trustees Ltd
v Stena Line Ltd34 the court held that “the‘best interests of the beneficiaries’ should
not be viewed as a paramount stand-alone
duty. In my judgment, it should not betreated as if it were separate from theproper purposes principle… It is necessary
first to decide what is the purpose of thetrust and what benefits were intended
to be received by the beneficiaries before
being in a position to decide whether a
proposed course is for the benefit of thebeneficiaries or in their best interests…
In my judgment, it is clear from Cowanv Scargill that the purpose of the trust
defines what the best interests are andthat they are opposite sides of the samecoin.” Accordingly, it is now clear thatfor the purposes of equity and trust law“best interests” forms part of the general
purpose-related requirements that apply
to the exercise of powers, and is not a
stand-alone duty.35
In these contexts, it seems that the “bestinterests” maxim serves to keep thedecision-maker’s focus firmly on the
purpose for which the relevant powerhas been given to it, on the identity of
those for whose benefit that power is
to be exercised and on the fact that, in
exercising it, the decision-maker cannot
simply exercise that power as it thinks
fit (and, in particular, may not do so in

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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what it considers to be its own interests
or on the basis of its own moral or social
beliefs).36
1.31

1.32

Various regulatory rules also impose ‘best
interests’ obligations, some of whichreflect EU legal standards. Asset Owners
regulated by the FCA and Investment
Managers are required by the FCA’s
rules to “pay due regard to the interestsof [their] customers and treat themfairly” and to “act honestly, fairly andprofessionally in accordance with the bestinterests of [their] client”.37 For an AFM,
this second rule is modified so that it
applies separately in relation to any UCITS
scheme the AFM manages. Again, “bestinterests” are not defined and the rule
may well be intended to have a broader
focus than simply the exercise of powers.
However, it is clear from recent cases thatany duties under the “best interests” rule
are shaped by the relevant factual context,
including, in particular, any agreementwith the relevant client.38

appropriate advice from their investment,
legal, actuarial and other advisers, butmust ultimately make their own decisions.
1.34

1.35

Own decision requirement - a person
exercising a fiduciary power must not:(a) act under the dictation of another - therelevant decision-maker can take advice,and they can decide to follow advice,
but they must generally make their own
decision;39 or(b) fetter their discretion - the holder of a power
must not improperly bind themselves inadvance to exercise a power in a particular
way.401.33

450These duties mean, for example, thatthe trustees of a pension scheme musttake care not to fetter their discretion
improperly in entering into any
agreement with the sponsor or a scheme
member about the future exercise of theirpowers. Trustees can (and should) take

1.36

This is probably one area in which theduty of care (itself context specific) has
a role to play not only as regards theidentification of those factors, but as tohow far to go in seeking to discover them;“if a factor could not be discovered onreasonable enquiries or at an appropriatecost, then failure to consider it will not
be a breach of this test”.46 It further
appears that the weight that an Asset
Owner gives to particular relevant
considerations is a matter for it, subject
to the due consideration requirement (see1.43 below) and the test described in 1.40
below.47

The 2014 Report discusses the significanceof the views of non-employer beneficiaries
in this context and concludes thattrustees may consult beneficiaries, andconsider their views in making theirinvestment decisions, but there is no legal
requirement for them to do so.41 What
beneficiaries may want is not necessarily
the same thing as what will promote thesuccess of the trust.42
Proper information requirement - in thedecision-making process, a person musttake into account relevant considerations
and ignore irrelevant considerations.
This requirement is closely linked tothe duty of care (see 1.43 below) andthe rationality requirement (see 1.40
below). Although this test is similar to the‘process’ limb of the standard applied to
public authorities by Associated Provincial
Picture Houses v Wednesbury Corporation43(i.e. whether the right matters havebeen taken into account in reaching therelevant decision), the full rigour of this
aspect of the Wednesbury test has nothistorically been applied to trustees44.
However the Supreme Court decision in
Braganza v B P Shipping Ltd45 has arguably
changed the position; in this case, theWednesbury test was applied to the exercise
of a contractual discretion by a person(BP Shipping Ltd) which is not a publicauthority and was not acting in a fiduciary
capacity. It seems very likely that it will
be applied to the exercise of powers bytrustees and to the exercise of a fiduciary
power by others.
There is very little guidance about theidentification of relevant considerations.

1.37

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

The 2014 Report draws a distinction, towhich we return below, between:

ANNEXES(a) financial factors - i.e. considerations
which are likely to contribute positively
or negatively to anticipated returns orfactors which increase or reduce financial
risk; andJURISDICTION REPORTS(b) non-financial factors – i.e. considerations
which do not fall within (a).

1.38

Australia

BrazilCanadaChina

This broad distinction has subsequently
been adopted by their regulators in
relation to Pension Funds and life insurers(see further below).

European Union

Deciding whether a particularsustainability factor is a financial factor
or a non-financial factor is not necessarily
easy and the financial relevance of what
are often referred to as ESG factors
is not universally understood.48 The
most widely discussed example of asustainability factor which is likely to
be a financial factor for Asset Owners
is climate change.49 A factor which
may look, on the face of it, to be nonfinancial, can be a financial factor in
disguise because, for example, it may
have a very real impact on a portfolio

Netherlands

FranceJapan

South Africa
United Kingdom
United States

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company’s reputation, business modelor governance standards and thus its
value. For example, State Street Global
Advisers is pro-actively engaging with its
largest US and UK portfolio companies inan effort to enhance their human capitalmanagement disclosures and practices. Its
January 2021 guidance on lack of racialand ethnic diversity notes “Research
has shown the positive impacts diverse
groups can have on improved decision
making, risk oversight, and innovation,
as well as how management teams with acritical mass of racial, ethnic, and gender
diversity are more likely to generate
above-average profitability…homogenous
boards and workforces tend to refrainfrom challenging prevailing views. The
preponderance of evidence demonstrates
clearly and unequivocally that racial andethnic inequity is a systemic risk thatthreatens lives, companies, communities,
and our economy — and is material tolong-term sustainable returns.”
1.39

1.40

451

Where a decision maker concludes,
or ought to conclude (see 1.36 above),a financial factor is material to an
investment-related decision, that factor
must be taken into account (see further
1.55 below).
Requirement of rationality50 - following theBraganza case referred to in 1.35 above, thispart of the overall “rationality” test derived
from the Wednesbury case can usefully
be described as the “outcome” limb. It
focusses on whether, even though theproper information requirement has beenmet, the decision reached is so outrageousthat no reasonable decision-maker could
have reached it. It is far less easy to show abreach of this limb of the rationality test,51
than it is of the “process” limb.52

1.41

Requirement of impartiality - A decisionmaker must treat those whom the power
is intended to benefit even-handedly; “It isof the essence of the duty of every trustee
to hold an even hand between the parties
interested under the trust. Every trustee
is in duty bound to look to the interests ofall, and not of any particular member.”53
So:

if he had only himself to consider; theduty rather is to take such care as an
ordinary prudent man would take if hewere minded to make an investment forthe benefit of other people for whom hefelt morally bound to provide”.60 It wasalso noted that the decision-maker must(where relevant) have regard “not only tothe interests of those who are entitled tothe income, but to the interests of those
who will take in the future”.61(a) those in the same position should betreated equally; and(b) those in different positions should betreated fairly.54
1.42

1.47

An Asset Owner regulated by the FCA andan Investment Manager are each requiredby FCA rules to “pay due regard to theinterests of its customers and treat themfairly”.55

Duty of care
1.43

1.44

1.45

1.46

Basis of duty - as the 2014 Report notes,“the law… has long recognised thattrustees owe a duty of care to theirbeneficiaries. A trustee who breaches
this duty is personally liable to theirbeneficiaries for the loss caused.”56
Investment Managers and other Asset
Owners are likely also to be subject to a
duty of care as an express or implied termof contracts relevant to investment-related
decisions or as a matter of tort.57
A firm regulated by the FCA is also subject
to requirements to “conduct its businesswith due skill, care and diligence”58
and “take reasonable care to ensure thesuitability of its…discretionary decisions
for any customer who is entitled to rely
upon its judgment”.59
Content of duty - in Re Whiteley, as regards
trustees’ duties it was held that, wheninvesting, “the duty…is not to take suchcare only as a prudent man would take

1.48

The 2014 Report explains (emphasis
added) “the primary purpose of theinvestment power given to pension
trustees is to secure the best realistic
return over the long-term, given the needto control for risks. We would emphasisethat this is a question of broad judgment
rather than mathematical formulae … wethink it would be helpful to make it clearthat trustees should take account of risks
to their investments … It is a matter fortrustees and their financial advisers toconsider what these risks might be andhow they should be evaluated”.62
Risk mitigation - the way in whichinvestors evaluate, and manage, risk
has evolved over time. Part 2D of theReport outlines how prevailing portfolio
theory has tended to focus attention on
managing risk and return at investment
portfolio level, structuring the portfolio
as a whole to realise the most efficient“risk-adjusted return”. It is this aspectof risk management which has received
attention by the courts, notably in Nestlev National Westminster Bank plc63 fromwhich it appears that, at minimum, thosesubject to duties of care are now required
to manage investment risk throughdiversification64 and by considering thesuitability of investments.65

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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1.49

1.50

1.51

452

However, as also noted in Part 2D of theReport, although reliance on the theories
and models described there is widespread,they suffer from some well-known
limitations. Perhaps the most relevant in
the current context is that diversification
does not address systemic risk66 unless therelevant risk has been fully reflected inmarket prices.67
Many sustainability factors pose arisk to the long-term health of socialand environmental systems on whichbusinesses and financial markets depend
and thus to whole markets and theinvestment return on all portfolios thatare exposed to them. They therefore need
to be taken into account by Asset Owners
in their investment-related decisions
where they are financially material to
the Asset Owner’s investment goals or
the investment objective of one of its
portfolios. As the Chief Executive of TPR
said in 201968 of one sustainability risk
“climate change is no longer simply asocial responsibility issue. It is a corefinancial risk impacting broadly acrossbusiness, the economy and markets.
Climate change is a risk to long-termsustainability pension trustees need toconsider when setting and implementing
investment strategy.” And the CFRF 2020
Guide69 says “many chronic risks will
not fully materialize for many years.
This could lead to a temptation to avoid
making potentially revenue-reducing
decisions now with an undefined
rationalization that the [Asset Owner]
could always exit the [investment] later.”
The potential systemic impact of theserisks means that they require a different
risk management approach. As the PRA
has said “the financial risks from climatechange have a number of distinctive
elements which present unique challenges
and require a strategic approach tofinancial risk management… whilefirms are enhancing their approaches tomanaging the financial risks from climatechange, few firms are taking a strategic
approach that considers how actions today
affect future financial risks.”70 These
are risks the potential future impact ofwhich is understood in broad terms, but
the timing and manifestation of that
impact is uncertain. An examination andassessment of historic data is unlikely tobe an appropriate risk management tool;
the use of future scenarios, metrics andtargets is more likely to be appropriate.
1.52

1.53

the likely costs to the portfolio. In otherwords, the financial benefit must not be“too remote and insubstantial” [Cowanv Scargill [1985] Ch 270 at 292] and must
accrue to the fund itself, not to the social
good in a more general way”.
1.54

Relevant judge-made law and legal commentary- we are not aware of any cases whichhave examined the duty of skill and careof Asset Owners or Investment Managers
against the evolving background of theappropriate approach to management ofsustainability risks. Nor are we aware of
any which have considered the standards
to be observed in relation to the exercise
of powers of stewardship in this context.71
However, the 2014 Report, though focusedon the position of pension fund trustees,
does provide some assistance as to how
a court might go about considering thisquestion. Its paragraph 6.53 recognisesthat “damage to the wider economy might
be considered a financial factor, as it will
impact on the scheme’s portfolio as awhole”. In other words, it recognises thepossibility that a sustainability factor canbe financially material to an investmentrelated decision. It goes on to say“However, for the decision to be justified
on financial grounds, the anticipatedbenefits to the portfolio should outweigh

1.55

This, we would suggest, points to the
distinction described in Part A.1.2.3 of
the Report between instrumental IFSI and
ultimate ends IFSI. In other words, aninvestment-related decision may, indeed
should, take into account a sustainability
factor which is financially material to thatdecision, but cannot necessarily take into
account one that is not.72 The passage says
nothing about the potential balancing act
an Asset Owner or Investment Manager
must perform in deciding whether it
is appropriate to incur costs or forego
benefits now in the expectation of benefits
in the future (through greater returnor risk reduction). These considerations
are of crucial relevance not only to theduty of care, but also to the conflicts ofinterest and fairness requirements alreadyreferred to (and, in extreme cases, theduty of rationality).
As regards the requirement that thefinancial benefit must not be too remote
and insubstantial, the facts of Cowan v
Scargill itself are helpful in casting lighton what this may mean, at least for
pension fund trustees, in the context ofa sustainability factor. In the case, fivetrustees of the Mineworkers’ Pension
Scheme who were appointed by the
National Union of Mineworkers, refused
to approve the scheme’s investment planunless it excluded investments in overseas
companies or in oil and gas, on the basisthat such investments were against union
policy, damaging to the coal industry and

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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therefore against beneficiaries’ interests.
The court held that:

others whose circumstances are similar
is generally relevant in determining
required standards of skill and care.
It should nevertheless be relied upondiscerningly; courts are likely to recognisethat there are different schools ofprofessional thought, and that market
practice should not be followed where
it is not appropriate in the relevant
circumstances, for example, where it
would be disproportionate to do so.73 The
conduct of the investment decision-makeris to be judged by the standards andcontext applying at the time the decision
was made, and not with hindsight. As
Hoffmann J noted in Nestle v National
Westminster Bank “one must be careful
not to endow the prudent trustee withprophetic vision or expect him to haveignored the received wisdom of histime”.74 Equally, standards do evolve, anddecision makers need to take care to keep
up-to-date with investment thinking; as
the CFRF 2020 Guide notes “this is the
beginning of a long journey and bestpractice will continue to evolve rapidly”.75(a) the relevant trustees were in breach of
their duty to put first the interests of theirbeneficiaries (which normally meant theirbest financial interests);(b) there may be circumstances in which
financially disadvantageous arrangements
may be in the beneficiaries’ best interests,
but the burden of proving this would rest
very heavily on the trustee proposing to
make such arrangements;(c) in this case, the proposed exclusion ofcertain types of investments was not in
the beneficiaries’ best interests. Retired
miners, and the widows and childrenof deceased miners, did not have thesame interests as the union and the coalindustry as a whole. The connection
between the coal mining industry andthe beneficiaries was “too remote andinsubstantial”, so the trustees should nothave based their investment decisions onwhether it would benefit the industry.
1.56

1.57

453

Looked at from a different perspective,
the trustees sought to take into account a
consideration which was not financiallymaterial to their investment-related
decisions. There needs to be a genuine
connection between the Asset Owner’s
investment goal and the sustainability
factor it is taking into account. Again, we
would suggest that, where appropriately
deployed, instrumental IFSI is capable ofbeing consistent with the judgment in
Cowan v Scargill.
Market practice - because the duty of careinvolves (essentially) the application ofan external, objective standard to theoutcome of a person’s decision-making
process (often described as a requirement
to take reasonable care), the behaviour of

1.58

Publicly available information - a court will
also want to look at what information
about the sustainability risks facing an
Asset Owner’s investment portfolio isavailable to them and their Investment
Managers. Portfolio companies
are required, or are being strongly
encouraged, to publish increasingly
granular narrative information about
the risks their businesses now, or will in
the future, face (see 1.60 to 1.62 below).
Investors are also asking for even more
pertinent information, for example,
the Institutional Investors Group on
Climate Change (IIGC), which represents
European investors with over $9 trillion
in assets under management or advice,

has recently written to 36 of Europe’s
largest companies76 asking them “to[ensure] material climate risks associatedwith the transition onto a 2050 net zero
pathway are fully incorporated into
[their] financial statements”.77 Investingwith Purpose is clear about the need forincreased and internationally consistentreporting standards for sustainability
and Investment Managers’ support for
the early adoption of TCFD by portfolio
companies and the use of other reporting
standards, such as those set by SASB, in
the interim.78
Consumer protection - products marketed to retailinvestors
1.59

Mutual funds and insurers sell investment
products to retail investors. The marketing
materials used to do this do not become
irrelevant following sale because they
shape investors’ reasonable expectations.79
Accordingly, if there is to be a materialchange in investment approach, itwould be necessary to consider whether
a communication with relevant
Beneficiaries is appropriate, if indeed sucha change is permitted under FCA rules andby any applicable contractual terms.

Narrative disclosure by portfolio companies80
1.60

As noted at 1.58 above, UK companies
are required to disclose an increasing
amount of information on the impact ofsustainability factors on their business.81
A company’s annual strategic reportmust include information on the risks,development and performance of thecompany82 and describe how the directors
have had regard to the matters set out
in section 172(1) when performing their
duty under section 17283. Guidance on
the contents of the strategic report makes
clear that this should include relevant

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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environmental and social matters.84
Broadly, larger companies are also
required to include specific sustainabilityrelated disclosures in annual reporting,including:(a) narrative information addressing (i)environmental matters (including theimpact of the company’s business on
the environment), (ii) the company’s
employees, (iii) social matters, (iv) respectfor human rights, (v) anti-corruption andanti-bribery matters;85(b) to the extent practical to obtain, specificclimate-change related information,
including annual greenhouse gas
emissions;86 and(c) a statement of the steps the company hastaken to ensure that their business andsupply chains are slavery free, or that they
have taken no such steps.87
1.61

For accounting periods beginning from 1
January 2021, premium listed companies
must make disclosures consistent
with the TCFD recommendations, on acomply-or-explain basis88 and the FCA
has published proposals in CP21/18 tointroduce equivalent requirements formost issuers of standard listed equity
shares for accounting periods beginningfrom 1 January 2022. In March 2021 theBEIS issued a consultation on requiring
mandatory climate-related financial
disclosures by publicly quoted companies,
large private companies and Limited
Liability Partnerships. This proposes that
[mandatory, lower level] TCFD-aligned
disclosure requirements should apply inrespect of accounting periods startingfrom 6 April 2022 to:(b) UK registered companies with securities
admitted to AIM with more than 500
employees;(c) UK registered companies not within (a) or(b) which have more than 500 employees
and a turnover of more than £500m.
More broadly, the UK government hasannounced proposals to introduce
mandatory TCFD-aligned reporting “acrossthe economy” by 2025.89
1.62

As regards reporting standards on othersustainability issues, the UK Government,
the Bank of England, the FCA, the FRC andTPR have jointly announced their support
for the proposals relating to sustainability
reporting, on which the International
Financial Reporting Standards Foundation
is currently consulting. These proposals
include the establishment of a new
Sustainability Standards Board, to sit
alongside the International AccountingStandards Board within the Foundation’s
structure and create global sustainability
standards.90 The UK has also committed
to “match the ambition” of the Taxonomy
Regulation as regards sustainabilityrelated disclosures.91

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES(a) all UK companies that are currently
required to produce the statements
referred to in 1.60(a) above;
454

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Expressions used in Sections 2 to 4

N.B: The use of the term “Beneficiaries” is forconvenience and should not be taken to imply
that the persons identified are necessarily owed
fiduciary duties by an Asset Owner or Investment
Decision-Maker.

EXECUTIVE SUMMARY

Pension Fund

Mutual Fund

Insurer

Asset Owner

Pension scheme trustees92 in relation to funded
occupational pension schemes and each LGPS authority
in relation to LGPSOIEC or the trustees of the AUT

Insurance company

Beneficiaries

Active, pensioner and deferred members and anyone
else who is entitled to, or who might receive, a benefit
from the scheme in the future.93 Arguably this includes
the funding employer of the pension scheme, as thescheme is fulfilling an objective of the employer by
providing benefits to its current and former employees,
and in the case of a DB scheme the employer is directly
exposed to the investment performance of the schemedue to its obligation to fund the scheme over time.94
Arguably, a broadly similar analysis applies in relation
to the LGPS95

Current unitholders

Each party to a policy contract with the insurer (i.e.
the “customer” for the purposes of the FCA’s rules) andany other person entitled to enforce the contract (forexample, under the Contracts (Rights of Third Parties)
Act 1999)

Pension scheme trustees, in relation to private sector
schemes, and each LGPS authority, in relation to LGPS

AFM – in the case of an OIEC, this is its authorised
corporate director

Investment Decision-Maker

As regards shareholder funds, as noted at Part
B.2.1.1, we are treating shareholders of an insurer as“Beneficiaries” due to their economic interest in the
management of the insurer’s assets.
Insurance company

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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2.

ASSET OWNERS’ USE OF POWERS OF INVESTMENT AND DIVESTMENT

2.1

This section considers the extent to which
and in what circumstances, each type ofAsset Owner is required, or permitted,
to use its dispositive powers to IFSI. The
freedom of each of the Asset Owners
discussed below to invest is constrainedby some laws designed to enhanceenvironmental or social sustainability.96
For example, anti-money laundering
legislation (which aligns with SDG 16.4) isdesigned to prevent terrorist and criminal
activities since they are inconsistent withsocial wellbeing97 and sanctions regimes
could be characterised in a similar way.
In the UK, to date, initiatives intended
to influence behaviour on specificsustainability-related issues have generally
been confined to disclosure requirements(for example on modern slavery, as
mentioned in 1.60(c) above), althoughstronger approaches could emerge in the
future.98 Unlike some other countries, UK
law does not prohibit the indirect fundingof cluster munitions.99

2.2

as in the railways, electricity, waterand maritime sectors). Some insurers
and other financial providers also
operate master trusts, which are single
multi-section occupational pension
schemes made available to employers oncommercial terms. Some major public
sector employers (such as the universities)
also use funded trust-based schemes thatare subject to the same legal regime as theprivate sector.
2.2.2

2.2.3

Pension Funds

Types of pension fund covered
Private sector schemes
2.2.1

456

Funded occupational pension schemesin the private sector are typically set up
under trust and comprise either DC and/or DB. Many schemes provide a mix of DB
and DC benefits to members and someschemes also provide hybrid benefits
that contain elements of both DB and
DC.100 Most commonly, a trust-based
occupational pension scheme will be
set up for the employees of a particularcompany or group of companies, though
there are also some large industry-wide
schemes for multiple employers (such2.2.4

schemes, the FIS will need to be agreed by
the trustee and the employer (in schemes
where the trustee has a unilateral
power to determine the contributions
payable by the employer, consulting
the employer will be sufficient, as with
the SIP). Regulations (not yet made) will
provide more details as to the content
of the FIS and the frequency with which
it should be reviewed. As the content
of the FIS will play an important role inshaping the investment strategy of thescheme, the interaction (and demarcationof roles) between the SIP and the FIS is
not yet generally understood and thoseregulations may clarify this.

Many private sector employers alsouse contract-based pensions (the mostcommon being personal pensions)operated by insurers. These are covered in
2.4 below.
For both DB and DC occupational
schemes, the investment strategy of thescheme is determined by the trustee
and must be set out in a statement ofinvestment principles (SIP),101 which must
be reviewed by the scheme trustee at least
every three years. However, the employer
must be consulted before the strategy isadopted or changed, and the employer can
be closely involved in shaping the strategy.
In addition, section 123 and Schedule
10 to the Pension Schemes Act 2021
(which have not yet come into force)
will amend the Pensions Act 2004 to
insert a requirement on defined benefit
scheme trustees prepare a “funding andinvestment strategy” (FIS), which is a
strategy for ensuring that the benefits
under the scheme can be provided overthe long term. Broadly speaking, the FIS
must specify both the funding level thatthe trustee intends the scheme to haveachieved at a specified target date andthe investments that the trustee intends
to hold on the relevant date. For many

2.2.5

2.2.6

In a DB scheme, a member receives a
pre-agreed level of income on retirement,
often expressed as a percentage of their
final or average salary. Under the Pensions
Act 2004, such schemes must undergo an
actuarial valuation at least every three
years, in which the value of the scheme
benefit liabilities or technical provisions
are determined by reference to actuarial
assumptions that are either (dependingon the scheme rules) agreed between
the scheme trustee and employer orchosen by the scheme trustee, following
consultation with the employer. The
actuarial assumptions will often takeaccount of the expected returns on thescheme assets. Any shortfall between theassets and the technical provisions must
be met by the employer in a recovery plansetting out the amount of funding to be
paid in over time. Hence a solvent funding
employer bears the financial risk of thescheme’s investments failing to generate
the necessary level of return.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

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United Kingdom
United States

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REFERENCES

In a DC scheme, a member’s benefit at
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retirement depends on the contributions
paid into the scheme by member
and employer, and the investment
performance associated with thosecontributions, and therefore the member
bears the investment risk. The resulting
amount can be used in several ways
including payment to the member as alump sum, the purchase of an annuity forthe member and setting up a drawdown
arrangements under which the member
can receive a non-guaranteed income
stream and later convert it to a single
lump sum payment. Hence, a DC scheme
investment strategy aims to generate acapital sum which provides the largest
possible benefit for the member, thoughtypically as a member approaches
retirement age, this aim needs to bebalanced against that of protecting thevalue already built up (with “lifestyling”
investment strategies being designed
to reduce investment risk, and hence
returns, over time accordingly).
2.2.7

457

Usually the trustee of a DC scheme willoffer the member a range of different
investment options (or chosen funds)
with specific investment strategies orasset classes, and the member has the
choice as to how to allocate their funds as
between these options, which members
can exercise depending on their individual
risk appetites. Many schemes will offer“ethical” chosen funds and it is common
for environmental issues to be a key factor
in their design. DC schemes’ trustees
must provide a “default fund” in which
members’ funds are invested in theabsence of any choice by the member. It
is estimated that currently around 95% ofmembers are in a default fund.102

2.2.8

DB schemes were traditionally morecommon. However, it is estimated that
59% of the members of private sector
workplace pension schemes are now
members of DC schemes.103 Following the
introduction of an automatic enrolment
regime by the Pensions Act 2008, mostemployees are automatically enrolled intoa workplace pension, unless they opt out.
Private sector auto-enrolment schemes
can be DB but are usually DC.

Funded public sector schemes104
2.2.9

Most public sector pension schemes
are unfunded DB schemes (though it isnormal to offer DC arrangements forthe investment of additional voluntary
contributions alongside the main scheme).
An important exception is the LGPS,
which is the largest funded statutory
public sector pension scheme in Englandand Wales.105 It is a DB scheme for theemployees of local authorities with acommon set of rules governing benefits.
Benefits are guaranteed by statute. Thereis no single pool of investments; these areadministered at a local level in a numberof separate funds, under the responsibilityof the relevant local authority (or in somecases a stand-alone pensions authority
acting on behalf of a number of local
authorities) and subject to various
investment-related duties under the LGPS
legislation and the general requirementsthat apply to decision-makers underadministrative law.

Overview
Private sector schemes
2.2.10 Investment decision-making by
occupational pension scheme trustees
takes place within a legal framework, thekey elements of which are:(a) the terms of the trust deed governing thescheme;ACKNOWLEDGEMENTS(b) statute and secondary legislation,106 inparticular the Pensions Act 1995,107 thePensions Act 2004108 and regulations madeunder the former Act, most relevantly thePrivate Scheme Investment Regulations.109
These specify, in particular, that.110

EXECUTIVE SUMMARY(i)the trustees must establish andoperate an effective system ofgovernance, including internal
controls, which is proportionate to
the size, nature, scale and complexityof the activities of the occupational
pension scheme111. Regulations
imposing additional requirements
on scheme trustees with a view tosecuring effective governance of thescheme with respect to the effects ofclimate change are to be made under
sections 41A to 41 C Pensions Act
1995;112(ii) trustees must usually obtain proper
advice before exercising theirinvestment powers;(iii) investment powers must be exercisedin a manner calculated to ensure
the security, quality, liquidity andprofitability of the portfolio as awhole, to keep the portfolio properly
diversified and are subject tocertain rules regarding the portfolio
composition and, as regards assets
covering a DB scheme’s technicalprovisions, must be invested in amanner appropriate to the natureand duration of the expected future
retirement benefits payable under thescheme;A. INVESTING FORSUSTAINABILITY IMPACT

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potential conflict of interest, in theirsole interests;113(v)

trustees must exercise investment
powers “so far as reasonably
practicable” with a view to giving
effect to the principles containedin the fund’s SIP (which thetrustee must ensure is written andmaintained). This must cover, among
other things, the trustees’ policies114
in relation to:(A) financially material
considerations over theappropriate time horizon of theinvestments,115 including how
those considerations are taken
into account in the selection,
retention and realisation of
investments;(B) the extent (if at all) to which
non-financial matters are
considered in the selection,
retention and realisation of
investments;(C) risks, including the ways inwhich risks are measured andmanaged; and(D) their arrangements with any
investment manager116 including,among other things, how thosearrangements incentivise theinvestment manager to makedecisions based on assessments
about medium to long-term
financial and non-financial
performance of an issuer;117 and(c) judge-made law, as described at 1.16 to
1.59 above. Trustees may not exclude
liability for any breach of the duty of care“in the performance of any investment
functions”.118
458

2.2.11 Under the Occupational Pension Schemes(Disclosure of Information) Regulations
2013 (SI 2013/3274) trustees must publish
the fund’s SIP online and they must also
publish, by 1 October 2020 (1 October
2021 for trustees of DB schemes), a
statement in their annual report on how
the policies in the SIP have been followed.
2.2.12 TPR encourages pension scheme trustees
to sign up to the Stewardship Code “witha view to improving long-term returns andreducing the risk of poor outcomes due topoor strategic decisions”.119 Investing with
Purpose recommends that a governmentsponsored dedicated council of UK
pension schemes should be established topromote and facilitate high standards ofstewardship of pension assets.120 This is
expected to lead to a significant increasein pension fund signatories to the code.
2.2.13 Under the Occupational Pension
Schemes (Climate Change Governanceand Reporting) Regulations 2021121 it isexpected that trustees of schemes with £5billion or more in net assets on their first
scheme year end date to fall on or after
1 March 2020 will become subject to theclimate governance requirements fromthe later of 1 October 2021 and the dateon which they obtain audited accounts
in respect of the relevant scheme year.
For trustees of schemes with £1 billion ormore in net assets these dates are set one
year later. For authorised master trusts,
the commencement date for the newrequirements is 1 October 2021. Schemes
will be required to publish a TCFD report(including covering the new governancerequirements) online by the date falling
7 months after the end date of scheme
year current on 1 October 2021 or 2022 (asthe case may be). The DWP will carry out

an interim review of the requirements in
2023 to identify best practice and with aview to extending the measures to smaller
schemes. The DWP will consult again in
2024 before deciding whether to extend
the measures to schemes with less than
£1 billion in net assets from late 2024 or
early 2025 and is encouraging smaller
schemes to begin to report on a voluntarybasis in the interim period.122
LGPS
2.2.14 LGPS authorities are not trustees but are
subject to broadly similar obligations123.
Under regulation 7 of the LGPS Investment
Regulations they must formulate an ISS
which relevantly must cover, as relevant:

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ANNEXES(a) “the authority’s assessment of thesuitability of particular investments andtypes of investments”;

JURISDICTION REPORTS(b) “the authority’s approach to risk,
including the ways in which risks are to
be assessed and managed”;

Brazil(c) “how social, environmental and corporate
governance considerations are taken into
account in the selection, non-selection,
retention and realisation of investments”;
and(d) “the authority’s policy on the exerciseof the rights (including voting rights)
attaching to investments”.
An LGPS authority is also required124 toprepare a Funding Strategy Statement
which addresses the issue of managing theneed to fund benefits over the long term.
It must be revised whenever there is amaterial change in policy on the mattersset out in the ISS.
2.2.15 Governmental guidance provides
that LGPS authorities should become
signatories to the Stewardship Codeand Investing with Purpose asks that

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this expectation is fulfilled by the endof 2022.125 The Ministry of Housing,Communities and Local Government
also intends to consult in 2021 on
implementation by LGPS of mandatory
TCFD-aligned disclosures by 2023.126
Legal requirement to use investment powers to IFSIFinancial materiality and investment horizons
2.2.16 As noted at 1.39 above and as reflectedin the requirements for a private pension
scheme SIP, trustees must take into
account a financial factor if they conclude,or ought to conclude, it is material.
The judgement of whether somethingis material is inextricably linked to theinvestment time horizon of the scheme.127
2.2.17 For the purposes of a pension scheme’s
SIP, “financially material considerations”
are defined as including (but not limitedto) “environmental, social and governanceconsiderations (including but not limited
to climate change), which the trustees ofthe pension scheme consider financiallymaterial”.128 For the purpose of the SIP,
“appropriate time horizon” is defined as“the length of time that the trustees of ascheme consider is needed for the fundingof future benefits by the investments ofthe scheme”.129
2.2.18 TPR provides guidance to help trustees of
DC schemes identify and assess whether
financial factors are material. For
example, it says:130(a) “a relatively minor negative financial
factor for the default fund or default
arrangement may have an impact ona very high proportion of the scheme
membership and may be of a material
concern to you. On the other hand, amaterial negative financial factor for an
additional [chosen] fund, in which only459

a handful of members are invested, will
still be a significant issue to members
impacted by it, and therefore will also be amaterial concern to you; and(b) determining what will constitute a
financially material consideration willoften involve professional judgement.”
2.2.19 The PCRIG Guide 2020 provides extensive
guidance on how to make this assessment
in respect of climate-related risk.131
The August 2020 consultation which
preceded the DWP Climate Risk 2021
consultation includes a letter from therelevant minister to the 50 largest pension
schemes which says “…I have sought
to put beyond doubt …the duties forpension scheme trustees to take accountof financially material considerations
arising from environmental, socialand governance (ESG) considerations,
including climate change – just as theywould any other financial risk…I believethat the circumstances in which neither
climate risks, nor ESG risks more broadly,
are financially material are likely to be
extremely limited – and therefore that it
is part and parcel of trustees’ fiduciary
duties to take account of these risks whensetting out investment strategy.”
2.2.20 As regards an LGPS authority, its
ISS is not required to distinguishbetween financially material and otherconsiderations. However, it is clear fromaccompanying government guidance132
that its position is similar to that ofa private sector scheme trustee. In
particular this guidance says:“

the overall aim of the fund must be toconsider suitability [of investments] against
the need to meet pension obligations as theyfall due. Assessing the suitability of different
investment classes involves a number offactors including, for example, performancebenchmarks, appetite for risk, policy on
non-financial factors and perhaps mostimportantly, funding strategy…The appetite ofindividual administering authorities for taking
risk when making investment decisions
can only be a matter for local considerationand determination, subject to the aim andpurpose of a pension fund to maximise
the returns from investment returns withinreasonable risk parameters…The law isgenerally clear that schemes should consider
any factors that are financially material to theperformance of their investments, including
social, environmental and corporate
governance factors, and over the long term,
dependent on the time horizon over which
their liabilities arise.”

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FranceWe have not found any specific guidance on what
is material.
Trust-based occupational pension schemes
2.2.21 The purpose of a pension trust is toprovide pension benefits to Beneficiaries
over a long period of time.133 Beneficiaries
range from members with pensions
already in payment to those who do not
expect to receive a benefit for decades.
As a March 2020 open letter sent by USS
Investment Management Ltd134 (March
2020 Open Letter) says “As asset owners,
our ultimate responsibility is to provide
for the post-retirement financial security

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of millions of families across multiple
generations. Since our commitment toproviding financial stability spans decades,
we do not have the luxury of limiting ourefforts to maximizing investment returns
merely over the next few years”.
2.2.22 As noted at 1.47 above, and as this passage
makes clear, it is not simply a question of
simply maximising short-term returns;
this would potentially favour Beneficiaries
close to retirement. The context andcircumstances of each particular scheme
are critical to the investment decisions of
the trustees; “the starting point is the dutyof the trustee to exercise their powers
in the best interests of the present andfuture beneficiaries of the trust, holding
the scales impartially between different
classes of beneficiary”.135
2.2.23 While the legal duties of trustees are, in
substance, identical (whether the scheme
is DB, DC or combined), their application
does differ, particularly given the abilityof members to select chosen funds (andchoose particular strategies) on the basisof investment option guides and otherexplanatory materials. The trustee’s
duties in designing the default fund for
DC schemes have broad similarities tothe selection of investment strategies for
DB schemes, but the time horizon of thedefault fund investment strategy would
typically be shorter and the trustee would
not need to take account of the employer
interest as it has no ongoing financial
exposure.
2.2.24 To support investment decision-making
generally, TPR136 has emphasised the needfor:(a) an appropriate governance framework;and460(b) an appropriate approach to risk
management, an area in whichappropriate training and advice may wellbe essential in any event.137
2.2.25 The discussion in the following
paragraphs focusses on climate change.
However, much of what is said potentiallyapplies to any other sustainability
factor. Other such factors may be lessdiscussed, and there may be relatively
sparse information about them, but, as
paragraph 55 of the statutory ”Guidance
for trustees of occupational schemeson governance and reporting of climatechange risk” makes clear, the process ofreview is a continuing one; “trustees must,on an ongoing basis, assess the impact of
the climate-related risks and opportunities
they have identified on the scheme’s
investment strategy, and the funding
strategy, where the scheme has one.”
Trustees should also remain alert to newand emerging risks which are relevant totheir scheme.138
2.2.26 The trustees must identify considerations
relevant to investment decision-making(see 1.35 to 1.40 above) against thisbackground and in the context of theirscheme’s own circumstances, including its
profile and maturity.
Financial factors
2.2.27 As noted in 1.39 above, a trustee’s
investment decisions should always
take into account any matters which
it has concluded, or ought to haveconcluded, are financially material tothose decisions.139 This is not restricted
to historic and immediate risk factors:“If we were to focus purely on shortterm returns, we would be ignoring
potentially catastrophic systemic risks toour portfolios…As asset owners with thelongest of long-term investment horizons,
more inclusive, sustainable, dynamic,
strong and trusted economies are criticalfor us to fulfil the responsibility we haveto multiple generations of beneficiaries…
Skeptics that continue to question thegrowing role of sustainability within the
global investment community should
realize that they are quickly becoming theminority” (March 2020 Open Letter).
2.2.28 The fact that a sustainability risk such as
climate change, is a systemic, and macroeconomic risk which diversification is notdesigned to address does not mean thattrustees can ignore it140 or assume that
it is a consideration that they can leaveto any Investment Manager they haveappointed.141 Nor can they assume that itis “priced in”.142
2.2.29 The PCRIG Guide 2020 notes that “allpension schemes are exposed to climaterelated risks, whether investment
strategies and mandates are active or
passive, pooled or segregated, growthor matching, or have long or shorttime horizons. Many schemes are also
supported by employers or sponsors
whose financial positions and prospects
are dependent on current and future
developments in relation to climatechange…. The impact on pension schemes
as investors may not be immediately
obvious or uniform. For example, whilst
the utility sector is one of the moststrongly exposed to climate policy risk,
it may contribute a relatively small
proportion of a typical pension scheme’s
investment portfolio. On the other hand,manufacturing may have a lower sectoralrisk but may constitute a larger part ofa pension scheme’s portfolio and may
therefore have a greater overall effect.

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Trustees need to consider the impacts
across their portfolios as a whole.”143
2.2.30 This is not the same as saying thatclimate change is a financially material
consideration in relation to investment
decision-making for every pension
scheme; the trustees of each scheme must
make that decision, taking into accountthe circumstances of their own scheme,144
and in compliance with the duties
described in 2.2.10 above. Equally, if
trustees do conclude that climate change
is a financially material consideration
to be taken into account, that decision
does not dictate which, if any, of the tools
they have available (power of investment
and disinvestment, power of stewardshipor public policy engagement) they may
decide to deploy and how - again thatdecision will be highly fact dependent. For
example, for trustees who have chosen apassive investment strategy, the power ofinvestment and disinvestment may not be
available at all or only to a very limited
degree.145
2.2.31 The ministerial foreword to the DWP
Climate Risk 2021 Consultation is helpful
in explaining that although there may
be climate change-related investment
opportunities “risk is the focus – butwhen pension scheme trustees seize
opportunities to decarbonise andtherefore reduce climate risk in theirportfolios we unleash the productive
power of our pension funds. They canbe at the forefront of seizing sustainable
opportunities – in the financial interestsof their members – by financing the green
tech and green energy revolution we willneed for the transition”.
2.2.32 The PCRIG Guide 2020 provides aroadmap of how trustees could approach461

the decision whether to integrate
climate change considerations into theirinvestment beliefs,146 in setting theirscheme’s investment strategy and ininvestment manager selection147 review
and monitoring. It also identifies a range
of decisions (for example, a change ofinvestment strategy, a change in strategic
asset allocation, a change in the timingof the move from growth to matchingassets or a change within asset mandates
or portfolio construction) to which climatechange considerations could be material.
2.2.33 In this context, the recent settlement in
the Australian case of Rest v McVeigh148,
is instructive. McVeigh, a young
beneficiary who will not be able to accesshis pension savings until 2055, allegedthat Rest (a superannuation fund) was(most relevantly) in breach of its dutyof care by failing properly to take into
account the risks of climate change. In
announcing the settlement, the trusteeof Rest acknowledged that climatechange was a material, financial risk tothe superannuation fund across manyrisk categories, that required active risk
identification and management.
2.2.34 The settlement does not imply that asimilar challenge to a UK pension scheme
would necessarily succeed, merely that it
could.149 In the face of such a challenge,
trustees who have taken a careful andreasoned decision, taking into accountrelevant considerations and ignoringirrelevant ones, supported by appropriate
advice, that climate change risk is notmaterial in the particular circumstancesof their scheme or that it is material
but the appropriate response is not
to change the current investment or
stewardship strategy, should currently

stand a good chance of defending theirposition successfully. However, the 2014
Report contains a useful “rule of thumb”
reminder: “the law requires that trustees
go through the right procedure to reach
their decision, keeping the purpose of
the trust at the front of their minds. In
practice, the more unusual the decision,
the more trustees will need to show thatthey have reached the decision in theright way.” The more unusual this kindof decision becomes, the harder it will be
to defend. Trustees should also ensurethat they keep up-to-date with evolving
standards (see 1.57 above).
2.2.35 Once trustees have decided that asustainability factor is financiallymaterial, their next decision is what (ifanything) it is appropriate to do to manage
the relevant risk. Depending on their
particular circumstances, they may decidethat IFSI is the appropriate approach.
This could include divesting from somesignificantly affected companies as partof a wider strategy directed at influencing
the activities of portfolio companies.
2.2.36 On the whole, it seems unlikely thata trustee would choose the powerof investment and disinvestment as
its primary IFSI tool, considered inisolation. If the chosen sustainability
factor is relevant to more than a verysmall proportion of a pension scheme’s
portfolio, a decision to divest completely
might, in practice, limit the diversificationof the portfolio to an extent which gives
rise to unacceptable risk of another kindor might adversely impact the returnon the portfolio. Further, divestment
removes the scope to influence theactivities of relevant portfolio companies
through stewardship activities150. The

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power of investment and divestment
might, nonetheless, be deployed tosupport stewardship activities directed at
influencing portfolio company behaviour
with a view to achieving positive
sustainability outcomes, through selective
over or under-weighting of particular
portfolio companies (or the possibilityof it) to reinforce the message.151 In thecourse of pursuing a wider IFSI strategy,
and viewed in the context of investment
market activity more broadly, it seems
reasonable to suppose that there could
be times when investment or divestment
might become the primary focus.
2.2.37 Although risk is likely to be the key
focus in relation to sustainability
factors, trustees should also remain
alive to investment opportunities too,
where these are consistent with thescheme’s investment goal. For example,
we are aware of investment strategies
that involve investment in companies
with poor governance, combined withstewardship designed to improvegovernance and enhance value. It is
possible to envisage sustainability-based
strategies that might work in a similar
way.152
Non-financial harm to beneficiaries
2.2.38 As noted at 1.35 above, trustees musthave regard to all considerations relevant
to a given decision. In its 2017 report on
pension funds and social investment,153
the Law Commission expressed the viewthat trustees cannot simply refuse to
take account of “non-financial” factorsthat may affect scheme members inall circumstances, however serious thepotential non-financial harm to theirmembers, because to do so would amountto an impermissible fetter on their462

discretion (see 1.32 above).154
2.2.39 It went on to give the hypotheticalexample of a DC scheme catering largely
for construction workers which had
invested in a construction project witha particularly poor safety recording andexpressed the view that the scheme could
not simply refuse to consider the riskof injury caused to its members by its
investment.
2.2.40 We agree with the Law Commission’s
conclusion that such situations are likely
to be rare and, as such, of very limited
practical relevance to IFSI, especiallybecause the trustees would still need toapply the two step Non-financial Factors
Test described at 2.3.44 below.
LGPS
2.2.41 In our view, the position of an LGPS
authority is similar to that of private
sector scheme trustee.155
Legal freedom to use investment powers to IFSI
2.2.42 We have explained above that, where atrustee concludes that a sustainability
factor is financially material to theprovision of pension benefits, it must takethat factor into account. This section deals
with non-financial factors. A sustainability
factor will fall within this category where
it is not considered by the trustees to be amaterial financial factor.
Private sector schemes
2.2.43 TPR guidance notes that non-financial
matters in the Private Scheme Investment
Regulations are not necessarily nonfinancial factors in the sense used in
the 2014 Report; “here, ‘non-financial
factors’ means the views of members andbeneficiaries156, including in relation to
ethical matters and their views on socialand environmental impact and present

and future quality of life of the members
and beneficiaries157. While these are given
as examples of non-financial factors,[trustees] may instead consider thesefinancial factors due to the way [they] view
their impact on investment returns.”158
2.2.44 The Law Commission concluded in the2014 Report that the law is flexible
enough to accommodate a trustee taking
account of non-financial concerns in
its investment decision-making process
where:ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSI(a) trustees have good reason to think that
beneficiaries would share the concern;and the decision does not involve a riskof significant financial detriment to thefund;

C. AREAS FOR LEGAL REFORM(b) (the Non-Financial Factors Test).159

JURISDICTION REPORTS

2.2.45 So how should trustees proceed when
faced with evidence of the views ofmembers and beneficiaries that they wish
their investments to address an identified
sustainability factor? As TPR notes,
trustees should first consider whether
the identified sustainability factor is a“financially material consideration”.
If it is not, the trustees could still bepermitted to take it into account if thecircumstances meet the Non-Financial
Factors Test.
2.2.46 The Non-Financial Factors Test has beenreferred to with approval by the Supreme
Court (albeit in a case relating to theLGPS)160 and forms the basis of regulatory
guidance from TPR for pension scheme
trustees.161 We therefore consider itlikely that the Non-Financial Factors
Test would at least be considered, andpotentially applied, by a court in theevent of challenge to a trustee’s use of asustainability factor it did not consider tobe financially material in its investment

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decision-making process.
2.2.47 There is nevertheless some legal
uncertainty about the basis of the NonFinancial Factors Test162 and applying itin practice may not be straightforward.
For example, trustees need to establish
whether they have a sufficient consensus
among beneficiaries.163 They will alsoneed to determine whether their decision
involves a risk of “significant financial
detriment,”164 taking into account, forexample, any lost opportunity cost
due to lower returns relative to otherinvestments.

2.3.2(a) investment companies with variable
capital, commonly known as open-ended
investment companies (OEICs);167 and(b) authorised unit trusts , which areconstituted as trusts.168
Some OEICs are listed and traded on
exchange as ‘exchange traded funds’(or ETFs)169 and so will also be subject tolisting and exchange rules, which we do
not consider in this Annex.170
2.3.3

2.2.48 It seems likely that it will not be common
for trustees to be comfortable taking into
account a sustainability factor which they
consider to be a “non-financial factor” intheir investment decision-making process.
LGPS
2.2.49 The position is likely to be the same as forprivate sector trustees. The principles in
the 2014 Report have been generally taken
to apply to LGPS authorities and wording
based on the Non-Financial Factors
Test has been adopted in governmental
guidance for LGPS authorities.165
2.3

Mutual Funds

Types of mutual fund covered
2.3.1

463

This Annex covers UK UCITS, which are
the most common form of regulated
retail mutual fund.166 At present, the UK
regime for mutual funds is broadly theEU’s UCITS regime brought onshore. It
therefore has the potential, in the future,
to diverge from the UCITS regime. In what
follows, matters which are particular to
the UK are described using “UK UCITS”,
whilst generally applicable features of theregime are simply labelled “UCITS”.

There are two principal UK UCITS fundstructures:

Investors acquire interests in the UK
UCITS, known as “units”, and are
generally referred to as unitholders. UCITS
must be “open-ended” so that there isno fixed number of units and units are
generally bought and sold on investor
demand.171

Overview
2.3.4

2.3.5

The OIEC, trustees of the authorised unit
trust and the AFM are all regulated by
the FCA. It is an important feature of the
UCITS regime that the AFM is responsiblefor day-to-day management of the fundand the making of investment decisions.172
Investment decision-making by an AFM
takes place within a legal framework the
key elements of which are:(ii) for certain funds,176 the investment
period over which the fund aims toachieve a positive return;(c) statute and delegated legislation, mostsignificantly:(i)the FSMA;(ii) for an OIEC, the Open-Ended
Investment Companies Regulations
2001 (SI 2001/1228));

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM(iv) the FCA rules specific to mutual
funds including:

JURISDICTION REPORTS

•

•

•

(b) the terms of the fund’s prospectus andother marketing materials, such as the“key investor information document”.173
These must set out (or in the case of the
KIID summarise):174
the fund’s objectives and investment
policy - a passive fund must also
give a prominent explanation of its
nature175;

EXECUTIVE SUMMARY(iii) the FCA requirements described in
1.21, 1.30, 1.43 and 1.46 above177 andthe further requirement that a firmmust take reasonable care to organiseand control its affairs responsiblyand effectively, with adequate risk
management systems (PRIN 2.1.1R(3));(a) the fund’s constitutional documents;(i)

ACKNOWLEDGEMENTS•

restrictions on the types of assets
in which the fund may invest,
including a limit on investment in
illiquid assets, and a requirement
imposed on the AFM to ensure aprudent spread of risk;178
a requirement imposed on the
AFM to invest in accordance withthe fund’s investment objectives
and investment policy;179 anda requirement imposed on
the AFM to act honestly,
fairly (including as between
different groups of unitholders),
professionally, independently
and solely in the interests ofthe fund and its unitholders incarrying out its functions180;
a requirement imposed on
the AFM to comply with all
regulatory requirements
applicable to the conduct of

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its business activities so as topromote the best interests ofunitholders and the integrity ofthe market.181(d) duties of care (see 1.43 to 1.58 above); anddocuments which have led to losses.
It is also possible that a unitholder
may have a direct claim against it
under section 138D(2) FSMA.186
2.3.7(e) fiduciary duties and duties connectedto the exercise of a power (see section 1
above).182
The AFM is responsible for drawing up
the prospectus and KIID and ensuringthat they comply with relevant regulatory
rules (including ensuring that theprospectus does not contain any untrue
or misleading statement) and is liable
to pay compensation to any person who
has acquired any units in the fund andsuffered loss as result of a breach of theserequirements.183
2.3.6

The UCITS structure and FCA rule bookprovisions makes for a complex series ofduties, broadly as follows:(a) the trustee of the authorised unit trustor the OIEC owes duties under theconstitution, relevant judge-made law andregulatory rules to unitholders184;(b) the AFM owes duties under the regulatory
rules to:(i)the OIEC185 or trustee as its client
in respect of all of its activities,
including its investment decisions. It
seems likely that a court would also
conclude it owes the OIEC or trustee
fiduciary duties, duties connected tothe exercise of a power and a duty ofcare (see section 1);(ii) unitholders, who are its clientsat least in respect of the activity
of issuing and redeeming units.
Separately, they may have claims
against it in respect of any material
inaccuracies in the marketing
464

An AFM is subject to disclosure
requirements under COBS 2.2B.9R,
where the investors in a scheme include
a pension fund or a life insurer. The
AFM must disclose annually (either
to relevant unitholders or generally)
how its investment strategy and theimplementation of it comply with its
arrangements with the fund or insurerand contribute to the medium- tolong-term performance of the scheme,
including reporting on:(a) the key material medium- to long-termrisks associated with the investments;(b) portfolio composition;(c) turnover and turnover costs;(d) whether and, if so, how, the firm makes
investment decisions based on evaluationof medium- to long-term performanceof a portfolio company, including nonfinancial performance.
2.3.8

The FCA has now published (in CP21/17)
its proposals for publicly available,annual entity and product level TCFD
disclosures for AFMs and OEICs without
a separate manager.187 Its underlying
intent is clearly stated in paragraph1.22; “improved transparency enables
clients and consumers to hold theirfinancial services providers to account.
This should encourage them to manage
climate-related risks and opportunities
effectively and direct capital towards
projects and activities that better support
the transition to a more sustainable,
low-carbon economy”. It aims to bring inrules for the larger firms (broadly thosewith £50 billion or more assets undermanagement) by 2022 with first disclosureby 30 June 2023 and for those with £5billion or more of assets a year later ineach case. It is proposed that, at entity
level:(a) governance, strategy and risk
management disclosures may be broad,but where there are material differences
for specific investment strategies, asset
classes or products, these will need to be
explained;(b) as regards scenario analysis, the disclosure
should cover approach, application ofanalysis in investment and risk decisionmaking process and, where reasonably
practicable, give illustrative quantitative
examples;(c) as regards metrics and targets, adescription of the target, including the
key performance indicators it uses tomeasure progress or an explanation as towhy it has not set a target; and(d) where investment management isdelegated, a TCFD-related explanation .
As well as being published on the website,
product level disclosures will need to be
included in the fund’s the annual longreport or half-annual report (whichever
follows most closely after 30 June),provided that the disclosures are always
included in the annual report. FCA is
proposing that, as regards the productlevel disclosures, a baseline set of core,mandatory, carbon emissions and carbon
intensity metrics would be included witha historical time series, after the first year.
Further less established, mostly forwardlooking metrics would be provided on a“best efforts” basis. Product level targets
should be included where relevant andthere are detailed proposals for scenario

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analysis. There are also proposals designed
to support the flow of information along
the investment chain, so that clients can
carry out their own scenario analysis
based on consolidated holdings acrosstheir investment products and mandates,
under which a client could annually
request data on the underlying holdingsof products in order to satisfy theirown climate-related financial reporting
obligations. Where permissible, thisshould include the relevant climate,emissions or carbon-related data.
Legal requirement to use investment powers to IFSIFinancial materiality and investment horizons
2.3.9

FCA rules include governance and risk
management requirements which are
relevant to these questions. For example,
COLL 6.6A.4R provides that the AFM must:(a) ensure a high level of diligence in theselection and ongoing monitoring ofscheme assets, in the best interests of thescheme and the integrity of the market;(b) establish effective due diligence policies
and procedures for ensuring thatinvestment decisions on behalf of thescheme are carried out in compliancewith the scheme’s objectives and theinvestment strategy and its risk limit
system188;(c) when implementing its risk management
policy, and where it is appropriate after
taking into account the nature of a
proposed investment, formulate forecasts
and analyse the investment’s impact on
the portfolio composition, liquidity andrisk and reward profile of the scheme
before carrying out the investment anduse reliable and up-to-date quantitativeand qualitative information in thisanalysis.189465

2.3.10 As to the AFM’s risk management
arrangements, Article 38(1) of the UCITS
Implementing Directive requires an
AFM’s risk limit system to deal with thescheme’s exposure to market, liquidity
and counterparty risks, and all other risks(including operational risks), which may
be material to that scheme.190 “Marketrisk”, in this context, includes systemicrisk impacting across a fund’s portfolio,
as well as idiosyncratic risk relating to thevalue of individual assets.191
2.3.11 As regards when such a risk may bematerial CESR’s risk management
principles for UCITS (CESR/09-178) statein paragraph 27 that “material risks
should be understood as those risks thatcan be expected, with reasonable level ofconfidence, to directly affect the interestof unit-holders.” There is no more specificguidance than this; probably because
the answer to this question is so context
specific. However, the UCITS’ investment
purpose (see 2.2.12 below), is the starting
point for determining which risks are
relevant, and may be material. The CFRF
2020 Guide provides useful context, andindicates that sustainability factors canbe material to a mutual fund for reasons
other than their obvious relevanceto value (eg through their impact onliquidity). As regards longer-term
investments which may lose value due toclimate risk, it notes that “an importantconsequence of falling asset prices, or ‘fearof falling asset prices’ can be illiquidity
in the markets or the triggering of othererratic market behaviour. With regards tofunds, this can lead to gating events andcash liquidity problems”.192
2.3.12 UCITS regulation does not specify atime horizon for determining financial

materiality. A mutual fund is different
from a pension fund in that it does nothave an in-built, potentially decades long,time horizon in the same way as a pension
scheme does. However, this does not mean
it should take a short-term view. Unless(unusually) the fund has a specified orotherwise limited life,193 we think it isreasonable for the AFM to assume thatthe fund will continue in existence. It
also seems reasonable to assume thatits unitholders plan to hold units for, atminimum, the investment period (if any)
it has stated in its marketing materials
as the period over which the fund aims
to achieve a positive return and torecognise that, since a fund will be open
for subscription and redemption on an
on-going basis, this period is effectively
a rolling one from the perspective of
the fund.194 Further, unitholders canbe expected to want value growth overthe period for which they hold. For the
purposes of the risk limit system, the AFM
will need to determine an appropriate
time horizon against the background of
the investment purpose of the relevant
UCITS and in doing so, it will need toensure that it is acting in the best interestsof the scheme (see 1.30 above), acting
in the best interests of unitholders andacting fairly as between different groupsof unitholders (see 2.3.5(c)(iv)(D) and (C)above).195
Other considerations
2.3.13 The object (or purpose) of a mutualfund provides the starting point within
which decisions about the exercise of
its investment powers are to be made.
This must be set out in its constitutional
document which is required to specify
types of investments and assets in which

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it may invest and that it “is to invest inproperty of that kind with the aim of
spreading investment risk and giving
unitholders the benefits of the resultsof the management of that property”.196
This broad purpose is generally refinedby the investment objectives (which are
invariably, but not exclusively, financial)and investment policy set out in thefund’s prospectus and KIID (see 2.3.5(b)(i) above. The FCA has provided further
guidance on the degree of specificity
required “the FCA considers that it
would generally be necessary for anadequate description of the objectives
and investment policy to include relevant
elements of the investment strategy.
This description should explain thosefeatures of the investment strategy thatare fundamental to how the productis managed… If it is not the manager’s
strategy to invest in a particular area
where the investment policy permits
investment, this should be madeclear… If the manager’s strategy is tofocus on investments with particularcharacteristics, for example companies
who are growing their business rapidly,
this should be explained. If the manager’s
strategy is to be flexible about which
opportunities they consider best,
depending for example on their view ofthe market cycle, this should be madeclear.”197
2.3.14 So between them, the constitutional
document, prospectus and KIID establish
the purpose by reference to which the
AFM’s investment decisions are to be
made, taking into account various otherrequirements described above andthe output of the governance and risk
management requirements referred to in
2.3.9 above.
466

2.3.15 In our view, an AFM should always
consider what factors are financiallymaterial to the fund, including
sustainability factors where relevant,and then take into account any it hasdetermined, or ought to have determined,
are financially material.
2.3.16 If an AFM concludes that a particularsustainability factor is financiallymaterial, it must then address the further
question of what (if any) action to take. In
principle, this could include the questionof whether it should pursue sustainability
impact goals. The matters which are likely
to have the greatest influence on thisdecision would seem to be:(a) the published investment objectives andpolicy - so, for example, it is likely to bedifficult, if not impossible, for an AFM ofa passive fund to take a decision to invest
outside the components of its index or
to divest one of those components. Given
that the FCA has said that it is necessary
to be clear in marketing material where
it is not the AFM’s strategy to invest in
a particular area where the investment
policy permits investment, even for otherfunds, the introduction of some kind ofsustainability exclusion may, dependingon the number, importance and potential
financial impact of the companies likely
to be excluded, be difficult, without(at minimum) appropriate notice tounitholders (see further 5.3.3 below);198
and(b) the timing of the impact of any costs
associated with that decision (including
opportunity costs) and of any anticipatedbenefits from it. In this context,
unitholders’ desire for growth over theperiod for which they are invested in thefund is likely to be relevant as are thebalancing considerations referred to in
2.3.12 above.
2.3.17 Overall, where an AFM concludes that itneeds to pursue a sustainability impact
objective (as compared with, for example,
moving investment away from assets
with high sustainability exposures) inorder to respond to a financially material
sustainability factor, we think it is most
likely that an AFM will decide thatstewardship is the most appropriate tool
to use, not least because of the potentiallyquite prescriptive framework set by afund’s investment objective and policy.
However, in the course of pursuing awider IFSI strategy, and viewed in thecontext of investment market activity
more broadly, it seems reasonable tosuppose that there could be times when
use of investment powers could becomea distinct focus. The power of investment
and divestment could also be coupledwith stewardship activities directed at
influencing portfolio company behaviour
with a view to achieving positive
sustainability outcomes, through selective
over or under-weighting of particular
portfolio companies (or the possibility ofit) to reinforce the message (where thispossibility is available in relation to thefund in question).
2.3.18 Regulatory intervention in relation
to an AFM which has not considered
whether climate change risk or any othersustainability risks are financially material
to its Mutual Fund, seems a more likely
outcome in the short term than successful
action by a unitholder. If challenged byunitholders, an AFM which has taken
a careful and reasoned decision (taking
into account relevant considerations andignoring irrelevant ones) that a particular

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B. THE EXTENT TO WHICH
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sustainability factor is not material in theparticular circumstances of the relevant
Mutual Fund or that it is material, butthat the appropriate approach is not
to change anything or take any action
should currently stand a good chanceof defending their position successfully.
However, the AFM should be alert tochanges in market practice and should
keep its decisions under review.

of that Mutual Fund which permits therelevant sustainability factor to be taken
into account as a non-financial factor,
the AFM will not have legal discretion to
pursue it in its investment decisions in
respect of the Mutual Fund.
2.4

Insurance undertakings

2.4.1

This Annex covers insurance undertakings
which are subject to Solvency II. It does
not cover any additional or different
considerations for (a) smaller insurers
which are not so subject;200 (b) life
insurance policies written in trust;201(c) self-invested personal pensions (inwhich the individual member selects theinvestments); (d) insurers operating in the
Lloyd’s insurance market; and (e) insurers
structured as mutuals,202 although theconclusions we reach may neverthelessbe relevant to these types of insurer andpolicy.

2.3.19 Although risk is likely to be the key focus
in relation to sustainability factors, theAFM should also remain alive to related
investment opportunities, where these areconsistent with the scheme’s purpose (see2.2.37 above).
Legal freedom to use investment powers to IFSI
2.3.20 We have explained above that, wherean AFM concludes, or ought to haveconcluded, that a sustainability factor
is financially material to a scheme’s
investment objective, it must take thatfactor into account. This section deals
with non-financial factors. A sustainability
factor will fall into this category where
it is not considered by the AFM to be amaterial financial factor in relation to
the relevant Mutual Fund. Regulation
and regulatory guidance indicate thatfor a UCITS to be permitted to take into
account a sustainability factor for nonfinancial reasons, it would need to beconsistent with its disclosed investment
objectives and policies to do so. FCA
guidance states that “sometimes funds set
out non-financial objectives, for example
environmental or social objectives, or statethat they are aiming to achieve a nonfinancial return. We expect, if a fund hassuch objectives, that it will set them out inits prospectus and its KIID”.199 As a result,in the absence of a disclosure in respect
467

2.4.2

A significant percentage of the investableassets of life and general insurers areinvested in public or private sector fixedincome investments (approx. 65% and
72% respectively) and a much smaller
percentage in equities (approx. 4% and
6% respectively).203 The aggregate value ofthe investable assets of UK life insurers is
significantly greater than that of generalinsurers.204

Types of insurance undertaking covered
General insurers
2.4.3

Life

The insurer underwrites property,
accident and sickness, travel, liability,
and other non-life insurance policies.
The insurer’s liability is to pay out whena valid claim is made by the relevant
policyholder. Any profits of investment
activity are retained by the insurer.

ACKNOWLEDGEMENTS

insurers
2.4.4

The insurer undertakes, as a matter ofcontract, to pay out a lump sum or regularincome on death or another defined event.
The amount payable may depend whollyor partly on profits from investment
activity. The main relevant policy types
are:(a) “With-profits” policies - these entitle
the relevant policyholder to at least aguaranteed amount on maturity, withthe total amount received based on theinvestment performance of the relevant
portfolio (through the addition by the
insurer of annual and a final discretionary
bonuses). Although the investment risk
is with the insurer in relation to theguaranteed amount (as supplemented byeach annual bonus when declared) thebulk of the investment risk is with thepolicyholder due to the usually significant
size of the final bonus. With-profits
funds are considered to be of declining
importance to insurers’ businesses andmany with-profit funds are now closed;205(b) Unit-linked policies - these are the main
alternative form of life policy206 and are
now much more common.207 Policyholders
select the notional “units” they wish to“purchase” with their premiums froma range of funds made available by the
insurance company. Returns payable
to the relevant policyholder reflect
the performance of the fund held andmanaged by the insurer in connection
with those “units”. Thus the investment
risk is with the policyholder; and(c) Group personal pension schemes these aredefined contribution workplace personal
pension schemes chosen by an employer
to offer to employees, structured as aseries of individual contracts between
208

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each employee and the insurer. The
insurer will typically offer a range of unitlinked209 funds in which a member may
choose to invest. However, under autoenrolment the provider cannot compel achoice.210 All schemes must offer a default
fund, to be used in the absence of member
choice. As with DC pension schemes, theinvestment risk is with the policyholder.
Overview
2.4.5

Insurers are regulated by the PRA (asregards prudential matters) and the FCA(as regards conduct of business matters).211
They are not, as regards policyholders,subject to fiduciary duties and nor are thepowers they exercise fiduciary powers, so
the judge-made law described in section 1
under “duties connected to the exercise of
a power” is not relevant, save:(a) to the extent reflected in FCA and PRA
rules; and(b) it would be prudent to assume thatdecisions relating to the investmentof policyholder funds212 may well be
subject to a rationality test comprisinga “process” limb (as described in 1.35
above) and an “outcome” limb (asdescribed in 1.40 above). This follows
from Equitas Insurance Limited v Muncipal
Insurance Limited213 in which it was held “inidentifying the scope of any term which
it is necessary to imply for the contract
to work in the way that the parties musthave intended or reasonably expected
it to work, the courts recognise that,
where the contract permits a party tomake a choice or requires it to make anevaluative judgment, it is for that party
and not the court to make the relevant
choice or evaluation. Consequently, theterm implied often imports a standard ofreview similar to that applied in judicial
468

review of administrative action whereby
the decision-maker is required only to act
honestly and reasonably in the Wednesbury
sense: see…Braganza v BP Shipping Ltd[2015] UKSC 17…paragraphs 19-30. Whatis honest and reasonable is judged byreference to the purpose(s) which thecontract requires or permits the party
exercising the relevant power to pursue.”
2.4.6

Investment decision-making by an insurer
takes places within a legal framework the
key elements of which are:(a) primary and delegated legislation,
including:(i)

FCA and PRA requirements describedin 1.21, 1.30, 1.43, and 1.46 above214
and the further requirementthat a firm must take reasonablecare to organise and control its
affairs responsibly and effectively,
with adequate risk management
systems (PRIN 2.1.1R(3)). The PRA
Fundamental Rules split theserequirements into two (rules 5 and6), with rule 5 giving extra emphasis
to risk - “a firm must have effective
risk strategies and risk management
systems”;(ii) requirements to maintain adequate
capital resources215 and sufficientliquid assets216 and comply withgovernance requirements;217(iii) requirements to invest in accordancewith the “prudent person principle”
which broadly requires an insurer
to make investments “the risksof which it can properly identify,
measure, monitor, manage, control
and report and appropriately take
into account in the assessment of its
overall solvency needs”218 and that all
the assets of the insurer are “invested

in such a manner as to ensure
the security, quality, liquidity andprofitability of the portfolio of assetsof the firm as a whole”;219(iv) the requirement that, in a conflict ofinterests, the insurer “must, or mustprocure that any third party which
manages its assets will, ensure thatthe investment of assets is made in
the best interest of policyholders”;220(v)

portfolio diversification
requirements,221 investable asset classrestrictions and obligations to ensurethat assets held to cover its technicalprovisions222 are invested in a manner
appropriate to the nature andduration of its liabilities and in the“best interests of all policyholders”,
taking into account any disclosed
policy objectives;223(vi) FCA rules specific to specific types ofpolicy. For example:•••

for with-profits policies, specific
COBS 20 requirements including
to “take reasonable care toensure that all aspects of its
operating practice are fair tothe interests of its with-profits
policyholders”;224
for unit-linked policies, specific
COBS 21 requirements, someof which only apply where
the policyholder is a natural
person;225 andfor group personal pensions,requirements for the insurer
to establish an IGC or(for smaller, less complex
schemes) a GAA to act solely
in the interests of relevant
policyholders226and the purpose

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of each of which includes
independent consideration of
the insurer’s policies (if any)in relation to, “ESG financial
considerations”, “non-financial
matters”, “stewardship” and“other financial considerations
to the extent that they pose aparticular and significant risk offinancial harm to the relevant
policyholders”227;

desirability of the company
maintaining a reputation forhigh standards of businessconduct and the need to act
fairly as between members of thecompany;(viii) judge-made law as to directors’ duties- courts are reluctant to interferewith directors’ decisions made ingood faith unless they are in breachof one of the other duties describedin (vii) above. Where there is noevidence of actual consideration of
the best interests of the company anobjective test will be applied; whether
an intelligent and honest man in theposition of a director of the company
concerned could in the circumstances
have reasonably believed that thetransaction was for the benefit of thecompany233;(vii) the provisions of the Companies Act
2006 and, in particular, the duties of
its directors:228(A) under section 172, to act in theway the director considers, ingood faith, would be most likely
to promote the success of thecompany for the benefit of its
members as a whole229;(B) to act within their powers andonly exercise them for the
purposes of which they are
conferred230;

469•

to exercise independentjudgement231; and•to act with reasonable care, skill
and diligence232.

•

When discharging the duty
described above, a director
must “have regard (amongst
other matters)” to the likely
consequences of any decision in
the long term, the interests ofthe company’s employees, theneed to foster the company’sbusiness relationships with
suppliers, customers and others,
the impact of the company’s
operations on the community
and the environment, the(b) duties of care owed to some policyholders,for example those holding long term
products where the amount payabledepends wholly or partly on profits frominvestment activity (see 1.43 to 1.58
above); and(c) in relation to certain types of life
insurance policy, life insurers which
distribute their own insurance products
will be required to assess the suitabilityof that product for the relevant potential
policyholder in certain circumstances;234;
and(d) where relevant, the terms of policyholder
documentation and related marketing
materials235. For general insurers,
policyholder documentation is rarely,
if ever, relevant to the exercise of theinsurer’s investment powers.
2.4.7

An insurer is subject to the following
public (or Beneficiary) disclosure

requirements (those in (c) to (e) apply tolife insurers only):(a) the narrative disclosure requirements
described in 1.60 to 1.62 above, whereapplicable;(b) Pillar 3 disclosures236;(c) to state how the main elements of
its equity investment strategy are
consistent with the profile and durationof its liabilities, in particular long-term
liabilities, and how they contribute to themedium to long-term performance of its
assets237;(d) regarding arrangements with its
investment managers (which, for thispurpose, is defined to include an AFM) andtheir duration and, in particular, how:(i)the arrangement incentivises theinvestment manager to:••align its investment strategy anddecisions with the profile andduration of the liabilities of theinsurer, in particular long-term
liabilities; andmake investment decisions basedon assessments of mediumto long-term financial andnon-financial performance ofthe portfolio company, and toengage with portfolio companies
in order to improve theirperformance in the medium- tolong-term;(ii) the method and time horizon of
the evaluation of the investment
manager’s performance and the
remuneration for asset management
services are in line with the profileand duration of the liabilities ofthe firm, in particular its long-term
liabilities, taking into account its

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absolute long-term performance238;
and(e) under COBS21, to notify unit-linked
policyholders of the risk profile andinvestment strategy for the linked fundat inception, before making any materialchanges and (in relation to conditional
permitted links) at other appropriate
times, taking into account a policyholder’sneeds239.
2.4.8

2.4.9

A life insurer which distributes life
policies to retail clients is likely to haveto disclose publicly the nature of its
commitment to the Stewardship Codeor its alternative approach.240 Although
Investing with Purpose does not makeany direct recommendation designed
to increase the number of insurers,
especially general insurers, who aresignatories to the code, the report’s
emphasis on the need for the development
and improvement of stewardship in the
fixed income markets may well have thiseffec.241
The FCA has now published (in CP21/17)
its proposals for publicly available,annual entity and product level TCFD
disclosures for life insurers in relation
to insurance-based investment products
and DC pension products. Further detailsof proposed thresholds and reporting are
given at 2.3.8 above, save that:(a) the initial threshold for life insurers
is proposed as £25 billion assets undermanagement or more;(b) the insurer’s TCFD entity report must,at a minimum, explain how climaterelated considerations have influenced its
decisions, such as asset manager selection,
judgements on the range of funds offeredand how these judgements reflect thefirm’s overarching climate change
470

strategy; and(c) product level reports would apply at thelevel of an individual fund or pre-set
investment portfolio within a particularinvestment or pension product;(d) as well as being published on the website,
product level disclosures would haveto be included in the annual report towith-profits policyholders or the annual
pension benefit statement or pension
drawdown statement (as appropriate),
whichever follows most closely after the
30 June annual reporting deadline.
Legal requirements to use investment powers to IFSIFinancial materiality and investment horizons
2.4.10 For some time, climate change has beenhigh on the PRA’s agenda as a potentiallymaterial financial risk for insurers (inthe case of a general insurer, on bothsides of its balance sheet). The PRA has
given insurers plenty of guidance on
what it expects its climate change-related
risk management arrangements to look
like - similar to those for other risks, but
taking account of the unique features ofclimate change-related risk - and some
guidance on relevant time horizons. These
expectations are potentially relevant to
the way an insurer should approach othersustainability risks.
2.4.11 SS3/19 explains the PRA’s expectations
relating to climate change risk. An insurer
should:(a) embed consideration in its governancearrangements, including taking asufficiently long-term view of the financial
risks of climate change (which can arise
beyond standard business planninghorizons);(b) incorporate the financial risks fromclimate change into existing financial

risk management practice. For example,
under the ‘prudent person principle’(see 2.4.6(iii) above), an insurer should
consider whether there is an excessive
accumulation of financial risks fromclimate change in its investment portfolio,
and consider mitigants when this is thecase;(c) use scenario analysis to inform
strategy setting and risk assessment
and identification. Insurers should use
scenario analysis and stress testing to
inform the risk identification process
and understand the short- and longterm financial risks to their businessmodel from climate change. Insurers
are also expected to go beyond using
only historical data to inform their risk
assessment; the PRA Insurance Stress Test
2019 climate change exploratory scenarios
required participating insurers to consider
climate change-related risks as far into the
future as 2100.242
2.4.12 The CFRF 2020 Guide243 suggests that
“good practice is to treat climate risk asa cross-cutting risk type that manifests
through most of the established principal/
standalone risk types. Whether treatedas a principal risk or a cross-cutting
risk type, linkages of climate risks withestablished risk types (particularly
the more material risks such as …
credit… and financial market) should beestablished and understood…Undertaking
a materiality assessment of climate risks
will help the insurers to decide which isthe best approach [for them].”
2.4.13 The PRA has now said that it expects
insurers fully to have embedded a
proportionate approach (that reflects their
exposure to climate-related financial risk
and the complexity of their operations) to

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managing climate-related financial risks
by the end of 2021.244
2.4.14 Neither PRA nor FCA has given guidanceon what financially material means. The
CFRF 2020 Guide points out “a small firmwith large exposure to climate risk due
to geographic245 or sectoral concentration
may have to implement a moresophisticated climate risk approach than amuch larger firm with less exposure”.246
2.4.15 The regulator’s position on time horizon,
is however, much clearer - as regards
shareholder funds the time horizon
tends towards the expected lifetimeof the insurer247. For life insurers, the
FCA has recently provided time horizon
guidance in relation to policyholders’funds248. This provides that the insurer
should take account of material financial
factors (including environmental, socialand governance factors that are material
to the sustainability of an investment)“over the period of time that the firm
reasonably considers is needed to achieve
the investment objective or investment
strategy”.249
General insurers
2.4.16 The nature of the relationship between ageneral insurance policyholder and theinsurer is qualitatively different fromthat between a long-term insurance
policyholder and insurer. The first is verymuch a debtor-creditor relationship, withprudential protection provided by the PRA
and some conduct of business protection
under FCA’s rules. A policyholder isdirectly interested in the insurer’s ability
to pay its claim as they fall due, but isotherwise not directly interested in theinvestment of its assets.250
2.4.17 As a result, and subject to compliancewith the rules described in 2.4.6 above,471

the key duties shaping the insurer’s
investment decisions are those of its
directors, in particular their section
172 duties. Section 172 refers to thepromotion of “the success of the company
for the benefit of its members as awhole”. This codifies earlier judge-madelaw, which referred to the “interests ofthe company” meaning the interestsof shareholders present and future.251
Prevailing commentary, with which we
agree, suggests that section 172 requires
directors to seek to balance short-term
considerations (affecting the present
shareholders only) against long-term
considerations that involve future
shareholders as well.252
2.4.18 So how might IFSI fit into this? Whilst an
appropriately balanced financial return toshareholders, present and future,253 for thelevel of risk they are taking by investingin the insurer is likely to be a key focus
for directors, their primary goal must be
pursuing the success of their company (sothat benefits to shareholders are derived
from this). In doing so, they should haveregard to a wide range of considerations,
including (but not limited to) thoselisted in section 172(1).254 Within theframework set by the PRA, as described in
2.4.11 above, the CFRF 2020 guide gives
a great deal of information as to how aninsurer’s directors could consider climatechange (and therefore, in principle, othersustainability factors). It notes that aninsurer’s “risk appetite should reflect andcommunicate the level of climate financial
risk that an institution is willing to take,tailored to the business model, and may
incorporate broader considerations basedon Environmental, Social and Governance(ESG), reputational risk or corporate
responsibility, (e.g. following a no-harmapproach) which may already be in place
within the firm….Risk appetite statements
tend towards a 3- to 5-year time horizon,
i.e. in line with strategic planning, but thefinancial risks from climate change may
not materialise within such a short timeframe. A mature appetite should therefore
consider the impacts over a longer period,e.g. a 30-year timeframe with interim
milestones”.255
2.4.19 We expect that many general insurers willconclude that they should treat climatechange as a financially material risk to
the asset side of their balance sheet aswell as to the liability side. Directors who
have reached this conclusion will thenneed to decide what, if any, actions totake consistent with their risk appetite.
This may mean a change to the insurer’s
investment goal, strategic asset allocation
or investment strategy, which wouldin turn need to be cascaded down to
the detailed investment objectives andinvestment policies which the insurer sets
for its Investment Manager.
2.4.20 Once a general insurer has decided thatclimate change or any other sustainability
factor is a material financial risk to its
investment goal or to one of its detailed
investment objectives or investment
policies or its success more broadly, it willthen need to decide what, if any, action
to take. That insurer could conclude
that instrumental IFSI is the appropriate
response in its particular circumstances.
A general insurer that reaches thisconclusion may have more scope thanpension fund trustees to invest or divest(particularly the latter) as part of its IFSI
strategy because it can choose a more
flexible investment goal and take into
account a wider range of considerations.256

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2.4.21 Although risk is likely to be the key focus
in relation to sustainability factors, ageneral insurer will also wish to consider
related investment opportunities too (seeparagraph 2.2.37 below).
2.4.22 Given the intense current focus of the PRA
and FCA on systemic risk, both climatechange and related to the pandemic, wewould expect both to be very interested
in an insurer’s systemic risk-related
decisions, including those concerning its
investments, and an insurer which does
not have good answers to their likely
questions should expect to be the subjectof at least informal regulatory attention.
In our view, regulatory intervention is agreater risk in practice than successful
shareholder litigation. There areconsiderable hurdles for a shareholder toovercome in order to take action against
a director for breach of duties which thedirector owes to the relevant company,
including the need to obtain permissionof the court.257 Action by the PRA or FCA
would not be directed at compensating
shareholders.
Life insurers
2.4.23 The analysis in relation to generalinsurers above is also relevant to theshareholder funds of life insurers. Where
the investment decisions of the insurer
do not materially affect payments topolicyholders (for example, where
policyholders will receive a fixed amountas they do under a fixed annuity contract),
the analysis for general insurers equallyapplies.
2.4.24 As regards policyholder funds related
to policies where the investment
risk is exclusively or largely with thepolicyholder, an insurer’s duties to its
policyholders must be overlaid. The
472

purpose of the policies and the promises
made in, or in connection with them,
become relevant. In the 2014 Report the
Law Commission asked, of insurancebased pension policies, “how far is theprovider required to consider risks to thelong-term sustainability of companies
in which they invest? And how far may
contract-based default funds apply
generally prevailing ethical standards?
In contract-based schemes, this is likely
to be considered as part of a duty of care,rather than a more general duty to act ina beneficiary’s best interests, and thereis even less guidance than for trustees.
Given that trust-based and contract-based
default funds perform the same function,
we think that the law should seek toachieve similar outcomes”.
2.4.25 The purpose of a life policy is generally toprovide an investment return or income inretirement for the policyholder. This could
be years, or even decades, in the future.
2.4.26 There are particular considerations inrelation to each of the kinds of policy
referred to in 2.4.4 above, as follows:(a) with-profits policies - insurers offering
with-profits policies may have significant
investment decision-making discretion,although insurers would need to ensure
they comply with policy terms ordisclosures, such as the Principles andPractices of Financial Management258
and meet policyholders’ reasonable
expectations. These are based principallyon what policyholders are likely to haveunderstood from the information given tothem at point of sale and are potentiallyrelevant to determining whether
policyholders are being treated fairly.259
Policy terms and disclosures, which canbe reasonably specific on investment

approach (and thus set policyholders’expectations) may constrain the methodsof securing the appropriate return;(b) unit-linked policies - unit-linked funds arelikely to have reasonably prescriptive
terms regarding the investment
strategy.260 The Association of British
Insurers’ Guide to Good Practice for
Unit-Linked Funds (2019 edition) says “thescope of the firm’s discretion in managing
the fund and the limits to that discretionshould be documented and disclosed topolicyholders and other relevant parties,
where appropriate, and reviewed whenrequired. This documentation provides
a clear point of reference against which
to review any decisions taken, helping
to provide clarity and certainty for allparties. Again, these potentially link tofair treatment requirements”;

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Australia(c) group personal pension schemes - as thesepolicies are typically unit-linked, theposition is likely to be as described in (b).

Brazil

2.4.27 Against this somewhat complex
background, an insurer should seek to
identify all financially material factors
and take them into account in its strategic
investment decisions. This will include
identifying factors that are material toits investment goal and factors that are
financially material to each separate
investment objective. On the assumptionthat it concludes that climate changeor any other sustainability factor is afinancially material factor in relation to
one or other or both of these matters,
it will then need to decide what, if any,actions to take consistent with its risk
appetite. This may mean a change to theinsurer’s investment goal, strategic asset
allocation or investment strategy, which
would in turn need to be cascaded down

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to the detailed investment objective andinvestment policy which the insurer sets
for relevant investment portfolios.
2.4.28 Where the identified financially material
factor is a sustainability factor, the insurer
could conclude that instrumental IFSI isan appropriate response in its particular
circumstances. If it does so, as regards
policyholder funds, it is more likely toconclude that stewardship is appropriate(supported by selective investment
and disinvestment or the possibility of
it where the assets concerned are notpassively managed). Having said this,in the course of pursuing a wider IFSI
strategy, and viewed in the context ofinvestment market activity more broadly,
it seems reasonable to suppose that there
could be times when use of investment
powers could become a distinct focus, so
far as permitted by policy terms. Scottish
Widows’ recently announced policy261 is
to divest from any company that derives
more than 10 per cent of its revenue fromthermal coal or tar sands, manufacturescontroversial weapons or violates the
UN Global Compact (UNGC) on humanrights, labour, environmental standards
and corruption. However, for some
UNGC violators, which will be priority
engagement targets, this is subject toa three year exception where (broadly)
Scottish Widows believes that the scaleof its investment means that it has thepotential to influence positive change,
with divestment being considered at theend of that period if there is no change.
This places a good deal of emphasis on
disinvestment, while still acknowledging
the importance of stewardship in
appropriate circumstances.
2.4.29 Even if the insurer is inclined, in473

principle, to set an instrumental IFSI goalfor one or more investment portfolios ofpolicyholder funds, the life insurer would
still need to confirm that to pursue thisgoal is consistent with relevant policy
terms and disclosures, in order to bepermitted to pursue the relevant IFSI goalor it would need to make appropriatechanges (see 5.4.3 below).
2.4.30 Any conflicts of interest arising fromdiffering investment approaches being
taken in respect of shareholder funds andpolicyholder funds or within policyholder
funds must also be resolved. This may not
be straightforward (see 1.23 above).
2.4.31 Again, risk is likely to be the key focus in
relation to sustainability factors, but a life
insurer will also wish to consider related
investment opportunities (subject to thevarious constraints already described); see
2.2.37 above.
2.4.32 Again, in our view, regulatoryintervention, especially in relation to
an insurer which has not consideredsustainability risk, is more likely thanshareholder action or policyholder
action. We have noted at 2.4.22 above,some hurdles to shareholder action. As
regards action by a policyholder, provided
the insurer has reached a careful andreasoned decision, taking into account all
relevant matters and no irrelevant ones
that the relevant sustainability risk is notmaterial or that no action is required andhas complied with applicable contractual
terms and the requirements of PRA andFCA rules and is not acting in a mannerinconsistent with any representations it
has made, the insurer should currently
stand a good chance of defending its
position successfully. Insurers should also
ensure that they keep up-to-date withevolving standards.
Legal freedom to use investment powers to IFSI
2.4.33 We have explained above that, where an
insurer concludes, or ought to conclude,that a sustainability factor represents amaterial financial risk to shareholder orpolicyholder funds (or any part of them),
it must take that factor into account, even
if the insurer also concludes that no action
can or should be taken for the time being.
This section is, therefore, only concernedwith sustainability factors which are notconsidered to be financially material.
2.4.34 It is clear from the CFRF 2020 Guide that
insurers are expected to identify, andmonitor non-financial risk. One example
is its own reputational risk. This seems to
us to provide an important indication of
the potential relevance of non-financial
factors.

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Australia

General insurers

Brazil

2.4.35 We have described at 2.4.16 and 2.4.17
above the key duties shaping the insurer’s
investment decision-making, in particular
those arising under section 172; theprimary duty of directors is to pursue
the success of the company (which is notdefined exclusively in financial terms) and,in doing so, they are permitted to haveregard to a wide range of considerations,
including those based on corporate
responsibility and other matters relevantto the insurer’s reputation. It seems clear
that, depending on the insurer’s precise
circumstances, an insurer could define its
purpose or develop a strategy in ways thatmight lead it to engage in IFSI in a mannerconsistent with its primary financial focus
but not necessary to its achievement; inother words to set an ultimate ends IFSI
objective. An example might be a generalinsurer which has decided that, for

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financial climate change-related reasons it
will not insure certain kinds of business,
and also chooses (for reputational, rather
than financial, reasons) to exclude therelevant companies from its investment
portfolio.
Life insurers
2.4.36 The analysis in relation to general insurers
above is also relevant to the shareholder
funds of life insurers. As regards
policyholder funds, an insurer’s duties to
its policyholders must be overlaid, as wehave explained at 2.4.24 to 2.4.26 above.
It appears that Aviva’s policy on cluster
munitions and anti-personnel mines isbased on non-financial factors, as therationale for it is Aviva’s commitment tohuman rights. This policy applies to its
shareholder funds and, wherever possible,
to its policyholder funds.262 However, adecision to exclude a significant businesssector, such as extractive industries, fornon-financial reasons would be much
more difficult to justify and much more
likely to be subject to successful challenge.
2.4.37 There is FCA guidance263 in relation
to policy holder funds setting out its
expectations on how an insurer may take
into account “non-financial matters” todemonstrate compliance with specified
FCA requirements. The guidance isbased on the Non-financial Factors Testand appears to assume that it is legallypermissible for life insurers to take
into account “non-financial matters”
in their investment decisions relating
to policyholders’ funds in certain
circumstances, even where not expressly
permitted under the policy terms.264 We
agree that an insurer ought not to beprevented from taking decisions based on“non-financial factors” simply because474

this is not expressly contemplated by
the policy terms, although contrary
indications in the policy terms orcollateral documentation could prevent
it. The existence of the guidance may
also provide some comfort that taking
non-financial matters into account is
consistent with policyholders’ reasonable
expectations.265
2.4.38 Broadly, the guidance applies toinvestment decisions affecting the types ofpolicy described in 2.4.4 above where thepolicyholder is an individual.266 It provides
that an insurer may take into account“non-financial matters”267 if:(a) the firm has good reason to consider
that the policyholders in question would
generally share the views on which thenon-financial matters are based; and(b) taking those matters into account would
not involve a risk of a significant financial
detriment to any affected investment.268
2.4.39 The guidance does not indicate how aninsurer should determine what level offinancial detriment would be “significant”
or how it should ascertain the views ofpolicyholders. As regards the latter, it isunderstood that the FCA’s considers thatviews of policyholders can be establishedthrough the typical methods firms use
in target market assessment, which may
include surveys or consumer interviews,
but that these steps are not necessarily
required provided the insurer has goodreason to consider policyholders, or the
relevant target market, share the viewsin question. It is also possible, in relation
to group personal pension schemes, that
information represented by policyholders
to IGCs or GAAs could assist.269

not be followed to achieve compliancewith the relevant rule or requirement.
Accordingly, insurers may well be able toidentify other ways in which to comply
with the FCA requirements to which it
relates. As regards group personal pension
schemes, the FCA may feel more strongly
that the guidance should be compliedwith because it reflects the position foroccupational pension schemes.

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3.

ASSET OWNERS’ USE OF POWERS OF STEWARDSHIP

3.1

The following section considers the extent
to which, and on what basis, each type ofAsset Owner is required or permitted touse its position to influence the activitiesof portfolio companies by engaging in
stewardship activities to IFSI.

Investing with Purpose
3.1.3

Overarching considerations
3.1.1

3.1.2

475

The ability of an Asset Owner to engage
with a portfolio company stems from adecision to invest in that company. So
its decisions regarding stewardship arealso shaped by the considerations set out
under “Overview of investment duties andpowers” in section 2 for each Asset Owner.
The scope for stewardship is probably
most easily understood in the context oflisted equities and the legal rights that
attach to them. An Asset Owner holding
equities, whether listed or private, has theright to vote on shareholder resolutions
and also a right to requisition such
resolutions. However, stewardship isfar from restricted to the use of voting
rights (see 3.1.9 below), and the absenceof voting rights in relation to fixedincome investments does not mean
investors are powerless. That said, theiropportunities to influence an issuer are
different and potentially more limited
to particular situations (for example,
when a portfolio company wishes to raise
new funds or refinance an existing debt
issue). There is also less institutional
experience. In recognition of the shift,in practice, of Asset Owners’ allocations
away from equity investments, Investingwith Purpose contains discussions on
stewardship behaviour in relation to
fixed income, private companies andreal estate and infrastructure, withrecommendations in each of these areas.271

ACKNOWLEDGEMENTS

3.1.4

This report notes “we have seen deeper
scrutiny of stewardship responsibilities
in the wake of the 2008 financial crisis
and in response to a number of highprofile corporate failures. Regulatorsand other stakeholders have recognised
the important role that stewardshipcan play in promoting well-functioning
markets and in turn increased their
expectations of investors living up to theirstewardship responsibilities…Following
a wave of regulatory interventions
focused on enhancing transparency andaccountability of stewardship practices,
the industry must now step forward tomeet the challenge of deepening andstrengthening the role of stewardship in
the UK.”272
The report goes on to say “stewardshiphas been a core feature of the UK’s
investment landscape for decades, withinstitutional investors seeking to ensurethat companies are well run and wellgoverned and taking account of their key
stakeholders…Initially this role focussed
on governance issues, but over the years
has expanded to consider the full range ofmaterial risks to investments, including
environmental and social factors…
To create long-term value for clients,
investment managers oversee and manage
the assets they invest in to encourage,
develop and support behaviour that willlead to sustainable returns. Collectively,
this work of allocating, overseeing andmanaging capital falls under the umbrellaof ‘stewardship’…The central purposeof stewardship is to generate sustainablelong-term value for the beneficiaries of
the investment process, who are the end

owners of capital…The integration of
stewardship and consideration of a wide
range of risks and opportunities, including
environmental, social and governance(ESG) factors in the investment processleads to better investment outcomes forclients. The assessment of these factors
informs investment decision making andstewardship activities - investors support
and challenge companies to better manage
material risks or impacts.”273
3.1.5

The report also makes clear that
addressing systemic risk is an important
purpose of stewardship “the UK
Stewardship Code recognises that bestpractice in stewardship involves…also
promoting the integrity of the market,
as the long-term value of investments is
tied to the resilience and strength of thewider economy. Effective stewardshiptherefore…includes responding tosystemic risks that undermine sustainablevalue creation.”274

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Delegation

European Union

3.1.6

FranceIn practice, many Asset Owners rely on
their Investment Managers to carry out
stewardship activities on their behalf.275
Investing with Purpose makes clearthat this aspect of their relationshipdeserves more attention; “asset owners
should express demand for stewardshipby communicating their investment
beliefs and objectives through thesignals, incentives and expectationstransmitted in selection, contractual
relationship and ongoing performanceassessment. This demand is critical toensuring that investment is focused onlong-term sustainable value…investment
managers do not always have a clear
view of their client’s stewardship

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priorities”.276 The report is critical of thefact that stewardship is not a core focus
in the selection process of an Investment
Manager or in the ongoing oversight andperformance assessments and indicatesthat it is still unusual for Asset Owners
to include stewardship expectations incontractual arrangements.277
3.1.7

3.1.8

476

As noted at 6.9 below, it is understoodthat, generally, Investment Managers takea firm-wide approach to stewardship.
The conflicts issues to which a firm-wide
approach gives rise are discussed in thatparagraph. Asset Owners need to beaware of these issues, but also of others
that a single approach on the part of an
Investment Manager raises for them. In
appointing an Investment Manager, they
will be seeking a cost-effective service thatis (ideally) completely and (at minimum)
sufficiently aligned with their investment
beliefs, risk appetite and investment goal.
So, as well as communicating what theywant and need in the Investment Manager
selection processes, they will also need tounderstand in detail what the Investment
Manager is offering and whether thismeets their needs.278 If the Investment
Manager is not able to offer what theAsset Owner needs, the Asset Owner willneed to consider whether it can costeffectively supplement the investment
management offering with its own
stewardship activities or by appointing a
specialist stewardship provider or whether
it needs to look elsewhere.
As noted, an Asset Owner should satisfy
itself that the Investment Manager’s
stewardship approach is sufficientlyaligned with its investment beliefs, risk
appetite and investment goal to meetits needs. If the Investment Manager’s

approach involves more extensive
stewardship activities than the Asset
Owner would itself choose to carry out(and especially if they potentially involve
investments belonging to the Asset
Owner), the Asset Owner will generally
need to establish with reasonableconfidence that the stewardship approachis unlikely to be damaging to the interestsof its Beneficiaries.279
The Stewardship Code
3.1.9

The framework for stewardship envisagedby the code can be summarised asfollows280:(a) Research - not only in due diligenceexercises prior to investment but on an
ongoing basis to inform investment andengagement decisions;(b) Ongoing monitoring – to assess the risks
and opportunities to long-term value;(c) Setting expectations – investors
communicate their expectations tocompanies;(d) Engaging - investors engage withportfolio companies to ensure that their
expectations are being met. They raiseissues which they think pose a material
risk to the company to understand how
companies are managing those risks andresponding to their concerns or views;(e) Collaborating and escalating - if acompany is not listening, an investor may
escalate their engagement, for example
by working with other shareholders,requisitioning resolutions at general
meetings, writing formally to the fullboard or making public statements. The
Stewardship Code also gives the example
of investors working together on athematic issue;(f) Exercising rights – investors make use of

voting and other rights as shareholders
to influence company behaviour. The
report recommends more proactive useof the power to requisition shareholder
resolutions as an engagement activity andasks the government to consider whether
changes are needed in UK company law tofacilitate their use281; and(g) Investment choices – Active managers
will buy and hold companies and assetsthat help them to achieve their client’s
investment goals and sell those that they
conclude will not.
3.1.10 Recommendation 13 of Investingwith Purpose is directed at improving
stewardship by educating portfolio
companies on the expectations arisingunder the Stewardship Code and its more
expansive definition of stewardship.
It recommends that the FRC, incollaboration with key stakeholders,develops resources for company
directors to deepen their understandingof stewardship and the code andcommunicate the need for constructive
engagement between investors andportfolio companies.
3.1.11 The framework described in 3.1.9 above
anticipates that an Asset Owner (or, inpractice, its Investment Manager) will
identify either before investment or
during the holding period factors which
are material to the value of the relevant
investment. These may be idiosyncratic
factors or they may be thematic, such as asustainability factor.
3.1.12 Since stewardship is inherently concernedwith changing the behaviour of portfolio
companies, in practice stewardship on
sustainability factors may often involve
activities that fall within the scope of
IFSI. A number of provisions of the

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Stewardship Code are consistent with theuse of stewardship as an IFSI tool:(a) Principle 4 provides that signatories
should identify and respond to marketwide and systemic risks to promote awell-functioning financial system andsignatories should explain, among otherthings, how they have aligned theirinvestment accordingly;282(b) Principle 6 requires signatories to takeaccount of client and Beneficiary needs
and refers to the length of the investment
time horizon considered appropriate todeliver to those needs; and(c) Principle 9 requires signatories to engage
with issuers to maintain or enhancethe value of assets. Their reports should
cover how engagement has been used
to monitor the company and how
engagement outcomes have informed
investment decisions (including decisions
to hold).
Duty of care
3.1.13 The 2014 Report recognises theimportance of stewardship283 and notesthat trustees have discretion over how far
to engage with companies and to exercise
their voting rights. It goes on to say “it isclearly in the interests of pension funds
as a whole to do all they can to promote
the long-term success of the companies inwhich they invest. We think that trustees
should be encouraged to consider whether
and how to engage with companies topromote their long-term success, either
directly or through their investment
managers”284.
3.1.14 The 2014 Report concludes that, incertain circumstances trustees’ duty ofcare may include duties which resemble
stewardship, citing the case of Bartlett v
477

Barclays Bank Trust Co Ltd [1980] Ch 515,
but only where a trust’s shareholding
confers a substantial measure of control
over the company. We think that it isworth re-examining this and especiallythe relevance of shareholding size,
particularly given the now widespread
opportunities for collective stewardship
activity; a group of Asset Owners withsimilar views may well have substantial
potential influence. We note that, inthe case, the court said “the bank, as
trustee, was bound to act in relation to
the shares and to the controlling position
which they conferred, in the samemanner as a prudent man of business.
The prudent man of business will act insuch manner as is necessary to safeguard
his investment. ….If facts come to his
knowledge which tell him that thecompany’s affairs are not being conducted
as they should be, or which put him on
inquiry, he will take appropriate action”.
This seems uncontroversial. It appears
to be the case that the judge considered
the main significance of the controllingshareholding to be that (i) it shouldhave enabled the trustee to secure theprovision of more detailed and regular
information than a minority shareholder
would receive, thus putting it in a position
to take steps earlier to safeguard its
investment, and (ii) it should have enabled
the trustee to prevent the company fromembarking on a disastrous scheme or tohalt it in its tracks. Again, neither seems
controversial on the particular facts. In
the context of a listed company, an Asset
Owner will not generally wish to receive
inside information from a portfolio
company, but will have more, and moreregular, information than is typicallythe case for a shareholder in a privatecompany, so the second of these points
seems the more relevant.
Matters to be considered
3.1.15 An Asset Owner (or its Investment
Manager) does not necessarily need to
be a controlling shareholder to accessinformation allowing it to identify arisk to a portfolio company’s long-termvalue (and thus to the investment of theAsset Owner). For example, for somesustainability risks generic information
is available on their likely economic
impacts. In addition, among others,
UK-incorporated portfolio companies
are required to produce an increasing
amount of information about theirapproach and exposure to sustainability
risks (see 1.60 and 1.61 above). An Asset
Owner (or Investment Manager) may also
be in a position to influence a portfolio
company’s behaviour with a shareholding
much smaller than a controlling one. In
addition, there is increasing recognitionof the benefits of stewardship, including
through collaboration; the opportunities
for collaboration are increasing andmarket practice is changing. What action
is appropriate (if any) in any particularsituation will depend on a number offactors and, although important, the sizeof the Asset Owner’s shareholding in therelevant portfolio company285 is only one
element of the overall picture.
3.1.16 In considering whether stewardship is
an appropriate response in respect of therelevant sustainability factor, an Asset
Owner’s investment goal and investment
strategy will be important. It will alsoneed to consider the effort involved
and the cost286 which should not bedisproportionate to the benefit expected(either in terms of enhanced value or

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B. THE EXTENT TO WHICH
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risk mitigated).287 Relevant further
considerations include:(a) the extent of the relevant Asset Owner’s“voice” (i.e. how influential it is with therelevant portfolio company or companies)and convening power (i.e. how likely itis that other Asset Owners will follow its
lead);(b) stewardship can take place in the context
of an existing portfolio (assuming theAsset Owner has decided it does not alsoneed to change its investment strategy
or strategic asset allocation in order topursue a given goal) and may therefore
help in balancing a need to maintaininvestment return in the short-term withpursuing a longer-term sustainability goal;

example, a systemic transition risk,
where one of the risks which the trustees’
action is seeking to mitigate is that of
rapid and unpredictable disruption toasset values and the risk of “stranded
assets” where apparently valuable assets(such as oil reserves) can rapidly lose
value due to climate change, regulatorychange or other external factors curtailingdemand.288
Collective action

3.1.17 Due consideration will also need to begiven to both short term and longer-term
impacts - for example, the stewardship
activity under consideration could involve
significant short or medium term costs forthe portfolio company to realise benefits
expected to accrue over a longer period(which may, in turn, have significant
income or valuation implications for the
Asset Owner and impact some cohorts ofBeneficiaries more than others).

3.1.19 As noted in 3.1.16 above and also in
Investing with Purpose (see 3.1.9 above),collective stewardship alongside otherinvestors is potentially important for anumber of reasons, including increasing
influence and spreading cost. In FS19/7“Building a regulatory framework for
effective stewardship” the FCA said
“several respondents stressed the valueof collective engagement to tackle
thematic or company-specific issues ofcommon interest across firms, especiallywhere individual engagement is notdelivering results. One respondent noted:‘Collective engagement is crucial to
overcome obstacles caused by fragmented
ownership, which is a particularly
acute issue for UK-listed companies…’
Stakeholders also said that collective
engagement could be an important way
of sharing expertise and sharing the costof otherwise expensive engagements…
we agree with stakeholders that collective
engagement can be an importantvehicle for investors to exercise effective
stewardship. This is particularly the casewhere ownership is highly fragmented
and individual investors may not havesufficient influence.289

3.1.18 Stewardship seems a particularly
appropriate tool in relation to, for3.1.20 Although these points were made in
the context of stewardship generally,(c) a range of stewardship techniques areavailable (from voting on shareholder
resolutions, to deeper engagement andalone or collectively);(d) the different impact on different classesof Beneficiary and the need to treat eachclass fairly - this may not be an easybalancing act (see [1.23] above); and(e) how much to do itself and how much todelegate to the Investment Manager or a
specialist stewardship service provider.

478

they have particular resonance for thechallenge of tackling a sustainability
risk, with its potential portfolio-wide
impacts. We have not identified any
express legislative or judge-made duty for
Asset Owners to collaborate in this way,or judicial recognition of such a duty.
However, there is scope for Asset Owners
to work collectively and it may well be acost-effective and efficient way to seek toachieve desired stewardship outcomes;
the possibility of engaging collectively
is therefore likely to be a significant
consideration in stewardship decisionmaking.
3.1.21 The FCA and its predecessors have on
several occasions clarified290 that theirown rules or other applicable legal
restrictions should not be taken to prevent
collective shareholder stewardshipdesigned to raise legitimate concerns, but
may impose some practical constraints
on what is permitted. The main legal
restrictions are:(a) Competition law - Co-ordination between
investors designed to wield collective‘shareholder’ influence over the ESG
strategy of a company in which they
are invested is likely to fall outside therealm of competition law, assuming nocompetitively sensitive information isshared between investors. Co-operation
between Asset Owners and/or Investment
Managers beyond this is possible, butneeds to be structured in a way thatcomplies with competition law since there
is no specific exemption to competition
law for arrangements designed to address
sustainability risks. Collaboration between
competitors amounting to price fixing,
collective boycotts, or the sharing ofmarkets and customers is almost never

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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permitted.291 A collaborative arrangement
involving the exchange of informationor the coordination of commercial
activities may also infringe competition
law if it is anti-competitive in object oreffect and is not otherwise exempt. In
most competition law regimes, exempt
arrangements must be necessary andproportionate in order to provide an
improvement to the production or
distribution process, or a promotion oftechnical or economic progress, whileallowing consumers a fair share of theresulting benefits, and still allowing
for sufficient residual competition in
the market.292 Parties are required toprovide quantitative evidence of such
improvements and consumer benefits ifthey wish to rely on such an exemption.
Like other competition authorities, the
UK CMA, recognising the importanceof sustainability on current and future
domestic and global agendas, hasproduced guidance on sustainability
agreements and is continuing work on
the topic.293 Moreover, to date, there are
no UK examples of competition action
against investors collaborating in pursuitof sustainability goals.294 However,while there is some guidance and caselaw, there there are not enough pastexamples to give certainty around whatevidence of sustainability benefits will
be enough in practice. Collaborative
arrangements entered into with a view
to improve sustainability outcomesmay not necessarily provide direct
improvements and/or consumer benefits
that outweigh their anti-competitive
harm, or to the extent that they do, thebenefits may be difficult to measure andprove in monetary terms. In addition,even encouragement by regulators or
479

government bodies for collaborative
action will not necessarily shield fromcompetition law scrutiny,295 or fromprivate competition actions brought bycompanies whose businesses are impacted
by collaboration between Asset Owners
and/or Investment Managers with a view
to improved sustainability outcomes.296
Such actions may be based on breachesof UK competition law, but could equally
be international cases based on breachesof EU or other applicable competition
laws and brought in the UK. The UK
CMA has stated that it wants to “ensurethat competition policy does not create
an unnecessary obstacle to sustainable
development and that businesses
are not deterred from taking part in
lawful sustainability initiatives in the
mistaken belief that they may breachcompetition law”.297 Additional guidanceis nonetheless required from competition
authorities (here, the UK CMA) to explainin more detail their attitude to investor
collaboration to address sustainability
risks and how sustainability outcomescan be quantified and assessed within theexisting horizontal collaboration regime.
Nonetheless, there remain a wide range ofcollective actions that Asset Owners may
take, based on existing law and guidance.
These include, for example:(i)collaboration towards non-binding
and non-individualised sustainability
goals (especially where parties areafforded a high level of discretion as
to the means by which they attainsuch a goal);298(ii) joint initiatives to develop standard
investment classification ormeasurement tools (provided there
are fair and equal rights to their use);(iii) exchanging information and bestpractice insights on IFSI (provided
the information is not competitively
sensitive);(iv) joint initiatives to enable the rise of
new markets and services;299 and(v)

joint advocacy/dialogue with
policymakers and stakeholders. Most
recently, competition regulators arealso increasingly open to discussing
sustainability initiatives and arestarting to recognise the need forfurther and more harmonised
guidance. There are a number ofconsultations ongoing that are
expected to clarify and, to somedegree, soften the past enforcement
climate and provide a better
framework to better account for
wider society benefits.300

Though operating within the margins
of competition authority guidance may
not prevent private competition actions
being taken against Asset Owners and/or
Investment Managers who act collectively,
it does lower the risk of such actions
being brought successfully, since a court
would assess whether the collaboration
was in line with competition law and thatjurisdiction’s relevant guidance.
(b) Securities market-related requirements - legal
rules relating to market abuse and inside
information301 and to the disclosure ofownership of shares,302 which are mainly
enforced by the FCA, may also serveto place some limits on the permitted
extent of collective stewardship, as may
mandatory bid and related requirements
under the Takeover Code.303

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
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REFERENCES(c) Industry specific issues – there are EU lawbased FCA and PRA consent requirements
in relation to ownership of financial
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services industry businesses which canbe triggered by for example, shareholders“acting in concert” or adopting a “lasting
common policy towards the management”
of an authorised financial services firmand similar issues may arise underlegislation specific to other industries.304
Again, this may impose constraints onwhat is permitted.

investments they must be exercising
discretion in relation to the compositionof the portfolio under management andnot in relation to some other function(such as proxy voting).306 It has also
specifically addressed the position ofpension fund trustees elsewhere in
PERG and has confirmed that a pension
fund trustee may generally carry out
stewardship activities without needing to
be authorised under the FSMA.307

View of regulator of financial markets
3.1.22 The FCA (which regulates financial
markets, as well as individual firms)
places considerable emphasis on effective
stewardship; “we think it is importantto acknowledge the role that effective
stewardship can play in promoting better
economic, environmental and societal
outcomes. However, we recognise theseoutcomes may be indirect, flowing frompursuing sustainable financial returns forclients and beneficiaries… Related work
…increasingly emphasises the role of theinstitutional investment community …
in promoting positive and sustainableeconomic, environmental and societal
outcomes.”305
3.2

Pension funds

Legal requirement to steward for IFSI
Private sector schemes
3.2.1

480

Pension funds are under considerablepressure to play a greater role in the
stewardship arena. As noted in endnote
10, one of the reasons pension fundtrustees delegate management of theirscheme’s assets to an Investment Manager
is to avoid the need for authorisation
under the FSMA. Helpfully for trustees
which wish to engage in stewardship
activities themselves, the FCA has
confirmed that for a person to be engaging
in the regulated activity of managing

3.2.2

The DWP August 2020 consultation
preceding the DWP Climate Risk 2021
Consultation includes a letter from therelevant minister to the 50 largest pension
schemes which said “I have sought to
put beyond doubt the requirement tohave a policy on stewardship of theassets, including both engagement
and voting, however the assets are
held…I believe it is part of trustees’
fiduciary duties to have a stewardshippolicy, even if that policy is limited toengagement and monitoring of the asset
managers who engage with investee
firms and vote on trustees’ behalf.”
Feedback included in the DWP Climate
Risk 2021 Consultation and related to
the August 2020 consultation suggeststhat respondents felt that not enoughemphasis was given to the importanceof stewardship as a risk management
tool. In this feedback the DWP says
“trustees have a duty to manage climate
risks which are a financially material
risk to the scheme, so engagement withcompanies…is very important in orderto help mitigate risks and drive the low
carbon transition.”308 The DWP’s statutory“Guidance for trustees of occupational
schemes on governance and reportingof climate change risk” emphasisesthat stewardship has other benefits

for trustees; “stewardship, including
engagement and voting activities,
can promote the long-term success ofpension schemes by encouraging investee
companies to take a long-term responsible
approach to their business strategy.
Through engagement with intermediaries
including consultants and asset managers,
as well as investee companies, trustees
will be in a good position to keep theirknowledge of climate change risk andopportunities up-to-date and learn about
governance approaches, strategies,
risk management tools, metrics andtargets.”309 In connection with this the
DWP has also launched the Taskforce on
Pension Scheme Voting Implementation
to support trustee-directed voting inpooled investment funds and promotevoting based on the preferences of pension
scheme trustees.
3.2.3

TPR has provided the following guidanceon stewardship to both DB and DC pension
schemes:(a) “It is up to the trustees to exercise
stewardship…[it] is particularly relevant
for the management of macro-economic,
systemic risks such as climate change,
which cannot be sufficiently hedged
through portfolio construction and asset
allocation alone”;(b) “we would encourage you to become
familiar with your managers’ stewardshippolicies. Where you consider it
appropriate, seek to influence them,and use stewardship as a criterion whenshortlisting and selecting managers”; and(c) “it is important to understand theimplications of the systemic risk ofclimate change on investment decisions
in the context of your scheme…Asclimate change is a systemic, macro-

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B. THE EXTENT TO WHICH
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economic risk, you should also consider
how engagement could be used tomitigate these risks by engaging withinvestee companies, policymakers andcollaborative industry initiatives”.310
3.2.4

3.2.5

481

As discussed in 2.2 above, trustees’
investment-related decisions should
always take into account matters thatthey have identified, or ought to haveidentified, as financially material.
If trustees decide that a particularsustainability factor is financially material
to the achievement of their investment
goal, their next decision is what, if any
steps, it would be appropriate to take inorder to mitigate any resulting risk. Witha sustainability risk using stewardshipto IFSI may well be a more appropriate
tool than over or under-weighing aparticular portfolio company (although,as discussed in paragraph 2.3.5, it may
also be appropriate to use stewardship andinvestment powers in combination). As
Investing with Purpose says “While someasset owners and investment managers
are divesting from greenhouse gas
intensive assets, the modern economy is
not yet set up to abandon these products
and industries altogether without
significant disruption to everyday life andfinancial stability. Accordingly, investment
managers also fulfil their management
and oversight responsibilities by actively
engaging with the companies they are
invested in to support them to manage thephysical and transition risks from climatechange and make progress to moresustainable business models”.311
Although a sustainability factor is rarely
likely to be material in relation to only
one portfolio company, it is, nevertheless,possible to envisage circumstances wherea trustee concludes that it should engage
with only one portfolio company in order
to seek to change its sustainability impact
because of its systemic significance.
Examples might be, where the company
in question is a systemically important
institution, a bellwether of a significant
industry or the owner or operator of aparticular critical piece of infrastructure.
Further, investment strategies of thesort mentioned in paragraph 2.2.37
above might lead an investor to engage
in stewardship, even if the goal is toenhance the value of the relevant portfolio
companies more than address systemicrisks.
3.2.6

Given the nature of the risk involved andthe significant pressure on trustees to, at
a minimum, consider the exercise of theirpowers of stewardship in the face of asystemic risk which they have identified
as material to their scheme, it would seem
unwise for trustees to omit to consider
whether to do so. Unless stewardship is
simply irrelevant to the investment stylechosen for the relevant scheme, it would
be surprising if a trustee did not conclude
that it should, at least, engage with its
Investment Manager on stewardship andmonitor their stewardship approach aspart of its overall monitoring process andalso, where possible, build appropriate
stewardship expectations into any
future appointment. Beyond this, thecircumstances of every trustee and its
scheme are different, and, as noted at
3.1.16 above, there are various potentiallyrelevant matters to consider on balance.
A trustee that has taken a careful andreasoned decision taking into account all
relevant factors and no irrelevant ones,
supported by appropriate advice, that it
is not appropriate to change its existing

stewardship practices, should currently
stand a good chance of defending its
decision successfully. Nevertheless,practices change over time and the Law
Commission’s “rule of thumb” in 2.2.34
above is a useful one to remember.
3.2.7

3.2.8

Trustees must include in the SIP theirpolicies on the exercise of rights,
including voting rights, attaching toinvestments and on how they intend toengage with their portfolio companies,
including when and how the trustees
would engage with issuers, asset
managers, stakeholders and co-investors
on matters including the issuer’s strategy,risks, social and environmental impact
and corporate governance.312
By 1 October 2021, the trustees’ annual
report will also need to deal withstewardship and voting practices covering:(a) the extent to which the trustees’ policyon the exercise of voting rights andstewardship has been followed; and(b) describing the voting behaviour by, or on
behalf of, trustees (including the mostsignificant votes cast during the year) andstate any use of proxy voting services.313
3.2.9

It looks as though further changes can be
expected in these disclosure provisions
for private sector schemes; Investing with
Purpose includes recommendations thatpension schemes should be required to
explain how their stewardship policies
and activities are in scheme members’
best interests and that TPR should issue
related guidance on how trustees might
evidence this.314

3.2.10 In addition, the TCFD-aligned disclosure
proposals referred to at 2.2.12 above
will include climate-related stewardship
activities.

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LGPS

LGPS

(i)

3.2.11 In our view, the position is similar for
LGPS. For LGPS, the ISS must contain the
LGPS authority’s policy on the exerciseof the rights (including voting rights)
attaching to investments and the TCFDaligned disclosure proposals referred to in
2.2.14 above will include climate-related
stewardship activities.315

3.2.14 In our view, the position for LGPS
authorities wishing to use IFSI to steward
on the basis of non-financial factors issimilar.

(ii) financial and non-financial
performance and risk;

Legal requirement to steward for IFSI
3.3.1

Legal freedom to steward for IFSI
3.2.12 As already noted, where a trustee
concludes, or ought to conclude, that asustainability factor represents a material
financial risk to the provision of pension
benefits, it must take that factor into
account, even if the trustee also concludes
that no action can or should be taken for
the time being. This section is, therefore,
only concerned with sustainability factors
which are not considered to be financiallymaterial.
Private sector schemes
3.2.13 A trustee should not take action on
the basis of such a sustainability factor
unless it is satisfied that to do so passes
the Non-Financial Factors Test. As noted
at 2.2.47 above, there are practicaldifficulties in the application of this test.
These difficulties may be less severe in thecontext of stewardship activities - given
the range of stewardship techniques
available, it may, for example, be easier
to conclude that the decision does not
involve a risk of significant financial
detriment to the fund (for example, by
way of direct cost or through negative
short or medium term impacts on
portfolio company distributions ormarket value as a result of the alterationin portfolio company activities throughsuccessful stewardship).
482(iii) capital structure; and(iv) social and environmental impact andcorporate governance;

Mutual Funds

3.3

The AFM must have in place strategies fordetermining when and how to exercise
voting rights attached to the fund’sinvestments to the exclusive benefit of thescheme concerned,316 which must adhere
to the disclosed investment objectives
and policy and must prevent or manage
any conflicts of interest arising fromthe exercise of those voting rights.317
These strategies must include measuresand procedures for monitoring relevant
corporate events.

strategy;(c) conducts dialogues with portfolio
companies;(d) exercises voting rights and other rights
attached to shares;(e) cooperates with other shareholders;(f) communicates with relevant stakeholdersof portfolio companies; and(g) manages actual and potential conflictsof interests in relation to its stewardship
activities.

EXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS(a) a summary description of the strategies
referred to in the previous paragraph; andAn AFM for such a scheme is subject tothe following further public (or relevant
Beneficiary) disclosure requirements
under COBS 2.2B.9R (see also 2.3.7 above)
where scheme investors include a pension
fund or life insurer:(b) (on request) details of the actions taken on
the basis of them.318(a) the use of proxy advisors for the purposeof engagement activities;

European Union(b) the firm’s policy on securities lending
and how that policy is applied to support
engagement activities;

Japan

3.3.2

3.3.3

3.3.4

3.3.5

ACKNOWLEDGEMENTS

An AFM must make available tounitholders:

In addition, an AFM for a scheme whichinvests in equities traded on a regulated
market must develop and disclose an
engagement policy and make an annual
public disclosure on how that policy has
been implemented, including a generaldescription of voting behaviour (the mostsignificant votes must be mentioned)319
and the use of the services of proxyadvisors.320
The policy must describe how the AFM:(a) integrates stewardship into its investment
strategy;(b) monitors portfolio companies on relevant
matters, including:(c) whether and, if so, which conflicts ofinterests have arisen in connection withengagement activities and how the AFM
has dealt with these.
3.3.6

CESR’s Technical Advice to theCommission CESR09/963 states “[a]decision to not exercise the voting
rights in certain circumstances, or
depending on the investment strategyof the relevant UCITS (for example,
UCITS following a passive investment
policy such as the index funds), could beAustralia

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South Africa
United Kingdom
United States

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considered as protecting the exclusive
benefit of the unitholders.” Whilst
this remains technically correct (andthere are circumstances in which, forexample, abstaining could be designed
to achieve a sustainability impact),
it does not represent the direction ofregulatory travel, especially in relation tosustainability risks. For example:(a) ESMA’s more recent Technical Advice
on integrating sustainability risk andfactors (ESMA34-45-688) acknowledges
that “many…respondents highlighted
that sustainability risks are not relevantin the same way for each investment or
portfolio. Therefore, these respondents
invited ESMA to make it more explicit
that the proposed requirements should beapplied in a manner that is appropriate
to the investment strategy of the relevant
portfolio….some respondents outlined
the importance of ESMA clarifying thatin …some scenarios [such as indexbased strategies where managers do nothave any or only limited discretion in
their portfolio management activities]
investment stewardship becomes anessential tool for fund managers to engage
with investee companies on sustainabilityrelated risks.” ESMA goes to express theview that the transition towards moresustainable and inclusive investment
growth should also rely on the principle ofstewardship; and(b) the joint FCA/FRC discussion paper“Building a framework for effective
stewardship” (DP19/1) notes “theinability [of index-tracking funds] to exit
investments increases the incentive toundertake stewardship activities and thelargest ‘universal’ holders do invest in
stewardship activities. On the other hand,
483

passive investors can compete largely on
the basis of lower fees, possibly increasing
incentives to free-ride on stewardshipbenefits provided by others rather thanincur stewardship costs themselves.”
3.3.7

The FCA/FRC discussion paper goes on toconsider that stewardship activities may
differ in nature between index-tracker
and actively managed funds and draws adistinction between “routine” and “deep”
engagement321 noting that there is value
in both types of engagement:(a) index-tracker funds may be more
likely to pursue ‘routine’ thematic
engagement strategies because they
conduct less detailed research on
individual companies. They may set
minimum expectations across all portfolio
companies for particular aspects ofstrategy or governance, such as executive
remuneration or board composition;322(b) an actively-managed fund, by contrast,
may be more likely to identify
idiosyncratic issuer-specific matters.
Where they choose to do so, therefore,
they may engage with issuers on a deeper
and more targeted basis.
3.3.8

3.3.9

The FCA’s feedback statement on DP19/1(FS19/7) records that some respondents
agreed with this distinction, but someindex managers strongly challenged it
and emphasised that they use their scale
and influence to set strong expectations
for portfolio companies on issues suchas climate change. These firms said their
thematic campaigns could be a catalyst formarket-wide change.
An AFM (whose stewardship decisions
are, in practice, generally limited to thestewardship aspects of its choice andmonitoring of the fund’s Investment
Manager and any stewardship provisions

in the investment management agreement
between them) must decide in relation toeach scheme for which it is an AFM andagainst the background of the purpose ofthat scheme (see 2.3.13 and 2.3.14 above)
which sustainability factors (if any) arefinancially material to that scheme.
3.3.10 In relation to any sustainability factors
the AFM has identified as material to
the relevant scheme, it will then need todecide what, if any stewardship activity
is consistent with the purpose of thescheme and otherwise appropriate andact accordingly. This assessment will needto take into account the effort and cost of
the relevant activity relative to the benefit
expected, and balance fairly the interestsof short and long term unitholders (see3.1.16 and 3.3.17 above and 2.3.16 and2.3.17 above). In particular, an AFM is
subject to specific requirements as regards
costs; it must prevent undue costs being
charged to a scheme.323 ESMA guidanceindicates that costs should be “consistent
with the investment objective of the fund”
and assessed against the backdrop of the“best interest” requirements.324
Legal freedom to steward for IFSI
3.3.11 Where an AFM concludes, or ought tohave concluded, that a sustainability
factor is financially material to a scheme’s
investment objective, it must take thatfactor into account. This paragraph deals
non-financial factors. A sustainability
factor will fall within this category where
it is not considered by the AFM to be amaterial financial factor in relation to
the scheme. As noted at 2.3.20 above,
regulation and regulatory guidanceindicate that for a UCITS to be permitted
to steward in relation to a sustainability
factor that is not financially material,

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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European Union
FranceJapan

Netherlands

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United States

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this activity would need to be consistent
with its disclosed investment objectives
and policies. As a result, if a non-financial
sustainability factor is not part of thedisclosed objectives or policy, the AFM will
not have legal discretion to pursue thatfactor in the fund’s stewardship activities.
3.4

circumstances, the directors of an insurer
could conclude that it is necessary toengage in stewardship activities (forexample, in relation to climate change orwith a particular systemically importantcompany) in order to achieve theirinvestment goal and stay within theirrisk appetite or in order to achieve theinvestment objective set for one or moreparts of its policyholder funds.

Insurance undertakings

Legal requirement to steward for IFSI
General insurers
3.4.1

A general insurer could choose to becomea signatory to the Stewardship Code, but
is not required by regulatory rules to havean engagement policy or make any related
disclosures. The discussion at 2.4.17 and2.4.18 above and that at 3.1.16 and 3.1.17
above applies equally to the stewardshipdecision-making process of insurers and,as indicated there, depending on their
particular circumstances, the directorsof an insurer could conclude that it isnecessary, for example, to engage with
one or more portfolio companies inrelation to a sustainability factor (suchas climate change) or with a particularsystemically important company in orderto achieve their investment goal and staywithin their risk appetite.

3.4.3

3.4.4

Life insurers
3.4.2

484

As regards shareholder funds, the positionis the same as it is for a general insurer. As
regards policyholder funds, as discussed
at 2.4.24 to 2.4.27 above, the overlay ofpolicy terms and related disclosures andpolicyholders’ reasonable expectations
provides an additional layer of complexity.
Subject to that, the discussion at 3.1.16
and 3.1.17 above applies equally to thestewardship decision-making processof insurers as regards policyholder
funds. Depending on their particular

Any conflicts of interest arising fromdiffering stewardship approaches being
taken in respect of shareholder funds andpolicyholder funds or within policyholder
funds must also be resolved, which may
not be straightforward (see 1.23 and 1.24
above).
The position for a life insurer as regards
the Stewardship Code is described in 2.4.8
above. In addition, a life insurer whichinvests in equities traded on a regulated
market must develop and disclose an
engagement policy and make an annual
public disclosure on how that policy has
been implemented, including a generaldescription of voting behaviour (the mostsignificant votes must be mentioned) andthe use of the services of proxy advisors.325
More detail on this requirement can befound at 3.3.4 above.

Legal freedom to steward for IFSI
3.4.5

As already noted, where an insurer
concludes, or ought to conclude, thata sustainability factor represents amaterial financial risk to shareholder orpolicyholder funds (or any part of them),
it must take that factor into account, even
if the insurer also concludes that no action
can or should be taken for the time being.
This section is, therefore, only concernedwith sustainability factors which are notconsidered to be financially material.

General insurers
3.4.6

On the basis described at 2.4.35 above weconsider it would be open to the directorsof a general insurer properly to conclude
that they are able to carry on stewardshipwith one or more portfolio companies
on non-financial risks to that company’sbusiness, including as part of an IFSI
strategy.

Life insurers
3.4.7

3.4.8

As regards a life insurer’s shareholder
funds, the position is similar. As regards
its policyholder funds, the position
is more complex because of the need
to overlay the insurer’s duties to its
policyholders (see 2.4.24 to 2.4.27 above)and insurers may also choose to follow the
FCA guidance described at 2.4.37 to 2.4.41
above.
Any conflicts of interest arising fromdiffering stewardship approaches being
taken in respect of shareholder funds andpolicyholder funds or within policyholder
funds must also be resolved, which may
not be straightforward (see 1.23 and 1.24
above).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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4.

ASSET OWNER’S PUBLIC POLICY ENGAGEMENT WITH A VIEW TO SUSTAINABILITY IMPACT

4.1

The following section considers the extent
to which, and on what basis, each type ofAsset Owner is required or permitted touse public policy engagement with a view
to IFSI.

in any adverse financial consequences
for them (for example, as a result ofany diminution in income likely to be
paid by a portfolio company, assuming
those public policy-related activities are
successful, or any potential fall in value of
portfolio company securities).

Overarching considerations
4.1.1

4.1.2

485

An Asset Owner’s power of public
policy engagement is different from its
dispositive or stewardship powers in that
it is unconnected with its ownership orcontrol of investments, although its levelof investment ownership (or in the caseof an AFM, control) may well determine
how likely policymakers are to listen to it.
So, for example, it is possible to envisage asituation where an Asset Owner concludes
that it is appropriate to exercise its public
policy engagement powers in a way thatis consistent with its overall purpose, but
is in pursuit of a less specific goal than its
investment goal.
We think that the duties to which an
Asset Owner is subject in exercising its
public policy engagement powers in thisway are rather more limited than when
it is exercising a fiduciary power such as
stewardship and that the matters it is able
to take into account in making its decision
to so engage are potentially broader. As
a result, it seems to us that the scope ofmatters on which it can use public policy
engagement is wider. The key relevant
duty it will need to observe would appear
to be the “no conflict rule” aspect of the
duty of loyalty326; a fiduciary must avoid
any unauthorised conflict between its
duty and its interest. This would, amongst
other things, require consideration of thecost327 to Beneficiaries of the proposed
activities and whether the proposed public
policy-related activity is likely to result

4.1.3

4.1.4

4.1.5

However, the power of public policy
engagement can also be used in a way
which is much more akin to stewardshipbecause it has a close connection withinvestment activity. Investing with
Purpose gives an example of this; “there
are key areas of public policy [in relation
to real estate and infrastructure assets]such as building and utilities regulations
which will impact on the long-termsustainability of these asset classes;
therefore, investors will also engage with
policy makers on these issues”.328 Whenused in this way, we would suggest that an
Asset Owner is subject to similar duties tothose which apply in relation to its powersof stewardship.

asset management groups which will
carry out more generally directed public
policy engagement on their own behalf,
funded from their own resources, rather
than from those of the UCITS the holding
company of an insurer and an Investment
Manager may carry out such engagement
on behalf of both, to ensure a unified
approach. Public policy engagement
through a trade association is also usefulnot just because it provides a collective
voice, but also because it can be a useful
way of conveying industry views on a nonattributable basis.
4.2
4.2.1

Part A.2.2.1 of the Report envisages threelevels of goal that are relevant to theconcept of IFSI - overarching sustainability
outcomes, portfolio-level goals andmore specific steps designed to realise
the portfolio-level goals. If public policy
engagement proposals form part of theportfolio level goals or the more specificsteps, we consider that the exercise of therelevant power is akin to the exercise of
stewardship powers.
An Asset Owner may well be part of amuch larger group and, where it is, it ispossible that public policy engagement
will be carried out by another groupmember. For example, many UCITS funds
and their AFMs are established by large

Pension funds

Private sector schemes
Where public policy engagement serves asa form of engagement or stewardship, aduty to undertake it may potentially arise
as described in 4.1.3 above. Otherwise, we
can conceive of circumstances where atrustee may conclude that it is appropriate
to use public policy engagement moregenerally, either through industry bodies
or directly. For example, the PCRIG Guide
2020 says “investor stewardship takes
place within a policy and regulatory
framework which is shaped by various
forces including governments, politicalparties, membership associations,
campaign groups and public opinion.
If trustees feel that the legislative
framework does not sufficiently support
them in acting as good stewards of theirassets, they should seek to influence
policy and regulatory initiatives”.329

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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Netherlands

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REFERENCES

LGPS
4.2.2

ACKNOWLEDGEMENTS

In our view, the position is similar for
LGPS, although their status as part of local
government may, in practice, affect theFreshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

UNITED KINGDOMCONTENTSFOREWORDSINTRODUCTION

type of engagement they wish or are able
to conduct.330
4.3

Mutual Funds
Similarly to pension funds, a duty to use
public policy engagement may potentiallyarise as described in 4.1.3 above. Otherwise,
although it is theoretically possible
for an AFM itself to use public policy
engagement (subject to conflict and costs
considerations as referred to in paragraph4.1.2 above) more generally, for practicalreasons, this is likely to be very unusual.
Many UCITS funds are established by large
asset management groups which will use
more generally directed public policy
engagement on their own behalf, fundedfrom their own resources, rather than fromthose of the UCITS.

4.4

Insurance undertakings

4.4.1

The PRA has made clear that it expects
insurers to use public policy engagement
where it is appropriate to do so; forexample, it “expects firms to engage
with wider initiatives on climate-related
financial disclosures and to take into
account the benefits of disclosures thatare comparable” 331.

4.4.2

The ClimateWise Principles industry
initiative, of which many UK insurers are
members, encourages members to disclose
how they “inform public policy making”
on climate-related issues.

General insurers
4.4.3

486

On the basis described at 2.4.20 above weconsider it would be open to the directorsof a general insurer properly to conclude
that they are able to use public policy
engagement with a view to IFSI. We
cannot easily identify a conflict in doing
this between the interests of the insurer
and the duties it owes its policyholders.

Life insurers
4.4.4

As mentioned in 4.1.3 above, there arecircumstances where engaging in public
policy serves as a form of stewardshipand a duty to engage in it may potentiallyarise. Otherwise, the position for life
insurers is similar to that describedin 4.4.3, save that the conflicts andcosts considerations outlined in 4.1.2
are potentially relevant in respect ofpolicyholders and policyholder funds.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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5.

ESTABLISHING NEW IFSI FUNDS AND AMENDING THE TERMS OF EXISTING ONES

5.1

Introduction

5.1.1

The following section considers the extent
to which it is possible for an Asset Owner
to set up a fund, policy or other productwith an express IFSI objective or amend
the objectives of an existing one. In 5.2
below, we have excluded considerationof a scheme which (i) has fewer than 100
members; or (ii) is being wound-up or
which is subject to a Pension Protection
Fund assessment period.332 5.4 below does
not cover the position of a general insurer
because the terms of its policies are not
relevant to its investment-related decisionmaking.

5.1.2

5.2

Product governance rules require
manufacturers of UCITS and insurance
products to specify a “target market”
for the product they are manufacturing.
Manufacturers must ensure that the
product’s characteristics are consistent
with that target market and must
regularly review their products forconsistency with the target market
that was specified.333 Manufacturers
must consider financial risks andprospective clients’ investment knowledge
and experience when determining
the appropriate target market, but
consideration of preferences in relation
to sustainability factors is not currently
required.334
Pension funds

Private sector schemes: establishing a new scheme
5.2.1

487

This question would only be relevant
to DB schemes on relatively rareoccasions, as they are generally now
only set up when existing DB schemes
are being merged into larger schemes oralternatively split on the sale or demergerof employer sponsor businesses. Hence
new schemes will typically be receiving
transfers of assets and benefits fromother DB schemes and would therefore
mirror existing investment powers andinherit existing asset allocations. However,new DC chosen funds can be establishedwith express objectives relating tosustainability factors.
5.2.2

5.2.3

Incorporating sustainability factorrelated objectives into a new DC default
fund would be permissible in respectof instrumental IFSI. Inclusion of asustainability factor-related objective forother reasons - as an ultimate ends goal
(e.g. to reflect beneficiaries’ desires toachieve certain sustainability outcomes)
may be possible, provided the financial
objective retains its primacy, but thecircumstances in which this can be done
are less clear. The approach which appears
to be encouraged by TPR is to establish
chosen funds which beneficiaries canselect.335
The view expressed in the 2014 Reportis that the Non-Financial Factors Test is
not relevant to this scenario. The Law
Commission’s view, with which we agree,
is that trust law permits significant
financial detriment to result from atrustee’s decision where the decision isexpressly permitted by the trust deed. DC
chosen funds involve a choice by membersof a specific fund based on its terms.336
This suggests that, as well as offeringchosen funds with a sustainability factorrelated objective that is additional to, butdoes not override, the financial objective,
it would be possible to offer a chosen fundthat incorporates a sustainability factorrelated objective, which risks some degreeof financial detriment when comparedwith other investment strategies, provided
that beneficiaries choose to invest theirmoney on the clear understanding thatthe investment approach may lead to alower return.
5.2.4

There is no TPR guidance reflecting the
Law Commission’s view. There would
therefore appear to be a risk of challenge
by TPR of a trustee which creates a fundthat prioritises a sustainability factorrelated objective ahead of financial
return, unless the scheme rules expressly
authorise this (which would be rare). It
may be that the FCA’s approach to grouppersonal pension schemes (see 5.4.2 below)
reflects TPR’s likely attitude.

Private sector schemes: amending an existing scheme
5.2.5

5.2.6

For DC schemes, although theoreticallypossible, it is likely to be difficult inpractice to amend an existing trust deed
to incorporate a sustainability factorrelated goal. To do so, a trustee would
need to be confident that it is acting
for proper purpose within the scope of
its powers, which are generally for thepayment of benefits. For DB schemes,balancing the interest of the employer
would make amendment of the trust deedmore complicated as the employer will be
responsible for making-up any shortfall
incurred as a result. Amendments must
be agreed with a potentially reluctant
employer.
To the extent not incompatible withthe terms of the trust, IFSI objectives orpolicies may be incorporated into the SIP
of an existing fund to the extent permitted
by the general law (see 2.2 above).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
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United States

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LGPS
5.2.7

5.3

An LGPS authority cannot set up new“funds” or amend the statutory termsof the scheme. An LGPS authority
could amend its ISS (in accordancewith necessary process requirements)
where IFSI is included to contribute to
optimising risk-balanced returns for
its beneficiaries (instrumental IFSI).
Amending for other reasons (e.g. to reflect
beneficiaries’ desires to achieve certain
sustainability outcomes) is likely to bepermissible only as far as compatible withapplicable guidance based on the NonFinancial Factors Test.
Mutual Funds

Establishing a new UCITS
5.3.1

488

A UCITS is an undertaking with the sole
object of collective investment, operatingon the principle of risk-spreading, ofcapital raised from the public.337 The
purpose of a UCITS must be reasonably
capable of being successfully carried
into effect338 and the fund’s constitution
must not contain any provision thatis unfairly prejudicial to the interestsof unitholders.339 These requirements
enable the FCA to refuse to authorise
UCITS that set objectives that it considers
would mislead or unfairly prejudice
investors. Subject to these limitations,
UCITS are permitted to have non-financial
investment objectives, which could
include non-financial sustainability
impact objectives, provided consumer
protections such as appropriate
disclosures are met.340 Current regulatory
developments and proposals are intended
to increase this trend.341 The number ofsustainability-related funds is increasing342
and it appears that there are some funds
on offer to UK retail investors that makedisclosures under article 9 SFDR indicatingthat they have sustainability goals as theirobjective.
5.3.2

The following requirements will also be
relevant:(a) Valuation and evaluation. Difficulties
measuring or valuing sustainability
impact (see Part A.2.3) may create
regulatory compliance challenges
for UCITS. The AFM is required toensure the prospectus includes “anexplanation of how investors can assess
the performance of the scheme” and“information which investors and theirprofessional advisers would reasonably
require… for the purpose of making an
informed judgement about the merits ofinvesting”.343 FCA rules impose detailed
requirements on the financial valuationof fund assets and the calculation andpublication of unit prices, to enable
unitholders to assess the merits ofinvesting and compare the UCITS against
other funds and benchmarks.344 However,the pricing and valuation requirements
do not contemplate the measurement
or evaluation of progress towards asustainability factor-related objective.
Given that sustainability impact isinherently difficult to value financially,
it may be difficult for a UCITS to provide
meaningful, comparable information
about its sustainability impact. Thisdifficulty is recognised by regulatorsand others as giving rise to potential
risks for unitholders who may be lessable to evaluate the fund’s non-financial
performance and less able to understandwhat they are being offered;345(b) Expertise. An AFM must “ensure it has
adequate knowledge and understanding of
the assets in which any scheme it manages

is invested”346 and must carry out its rolewith due care and skill;(c) Operational requirements. The AFM is subject
to operational requirements intended
to minimise risks to unitholders by
ensuring competent management of thefund. AFMs must ensure a high level ofdiligence in the selection and monitoringof assets and forecast the impact ofprospective investments on liquidity andrisk, based on reliable information.347
These operational requirements posepractical challenges that have been
acknowledged by regulators.348 For
example, conventional assessment tools
may not assist with the measurement ofprogress towards a sustainability factorrelated objective and limited availabilityof quantitative information could make it
difficult and costly to meet the required
standards of diligence.349
Amending an existing UCITS
5.3.3

An existing UCITS may amend its
investment objectives or policy. Achange of investment objectives orpolicy to permit ultimate ends IFSI,
even if an existing financial objective
retains its primacy, is likely to amountto a “fundamental” change and require
not only prior FCA approval, but also
approval by an extraordinary resolutionof unitholders giving a three quarters
majority.350 If an AFM concludes thatit must amend the fund’s disclosures
to permit instrumental IFSI this may
arguably be a “significant” change rather
than a fundamental one, in which case
the AFM need only give prior written
notice to unitholders,351 although FCA
approval may nevertheless be required.
There is little regulatory guidance on the
distinction between fundamental and

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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significant changes, but in both cases theeffect of the change on the scheme and its
unitholders is an important consideration.
A mutual fund’s depositary has a duty ofoversight in respect of changes impacting
investment powers under COLL 6.6.4R
and so will also need to be involved injudgements about the classification ofa proposed change. The Depositary andTrustee Association and the Investment
Association have produced joint guidance
for their members (dated October 2020)
on the Classification of Change Events for
Authorised Funds.
5.4

Life insurance products

Establishing a new policy
5.4.1

5.4.2

489

A life insurer may create products withsustainability factor-related objectives,
provided that applicable consumer
protection requirements, including withrespect to product design and marketing,are satisfied. The regulatory regime forcertain types of life insurance products352
specifically contemplates products which“target specific environmental or social
objectives”.353
In relation to with-profits and unit-linked
policies “deliberately designed to take into
account non-financial matters” which
policyholders have actively selected,354
FCA guidance suggests that “nonfinancial matters”355 may be prioritisedover financial return as “firms may
offer products that involve significant
financial risk that is not necessarily
compensated by the expected return,provided that consumers actively choosethese products, and that firms comply
with the relevant rules on distributing
such products.” However, it makes clearthat insurers offering “workplace personal
pensions” should not “offer products(including [chosen] funds) that involvea risk of significant financial harm toconsumers”.356
Amending an existing policy
5.4.3

Amendment to policy documents toincorporate an express sustainability
factor-related objective typically requires
policyholder consent. Gaining consent
may only be practical in relation to
those types of policy held by a single
policyholder. However, many suchpolicies are likely to be held by thetrustees of private pension schemes
which will need to comply with their own
duties in agreeing any amendment. For
other types of policy, the policyholder
outreach required to incorporate IFSI
into a significant proportion of an
insurer’s existing policies may make such
amendment impracticable.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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6.

INVESTMENT MANAGERS AND IFSI

6.1

The following section considers the extent
to which, and in what circumstances,
an Investment Manager is required or
permitted to IFSI on behalf of an Asset
Owner.

6.2(i)

an investment objective, investment
policy and any investment
restrictions (these are the main
provisions which delineate the extent
of the Investment Manager’s decisionmaking discretion as regards its
dispositive, stewardship357 and otherinvestment-related powers);358(ii) benchmark against which theInvestment Manager’s performance
will be measured and which is likely,
in practice, to be relevant to portfolio
construction;(iii) provisions on conflicts of interest(including to allow the Investment
Manager to act for other clients withconflicting interests and to deal withthe resolution of those conflicts);(iv) provisions on fees (these are usuallybased on the value of assets undermanagement, but may also include abenchmark-related performance fee)and costs;
(v)

490

model discretionary investment
management agreement (the Model
Agreement) defines the standard ofcare as “the standard of care that
could reasonably be expected of aprofessional discretionary investment
manager acting in good faith andwith reasonable care and skill”; andIn making an investment decision an
Investment Manager must take accountof:(a) the terms of its investment managementagreement (IMA) with an Asset Owner.
The IMA will typically include provisions
authorising the Investment Manager toact on the Asset Owner’s behalf and:a contractual standard of care.
For example, the Investment
Association’s widely used

ACKNOWLEDGEMENTS•

Although there is currently no express
requirement to solicit clients’ objectives
with regard to sustainability factors
as part of the suitability assessment,
it is considered good practice to do so,certainly as regards ESG;362 and(vi) limitations of liability.359
Provisions designed to incentivise theInvestment Manager to make decisions
based on a medium to long term
assessment of an investee company’s
performance (see 2.2.10(b)(v)(D)) for
private sector schemes and 2.4.7(d) forlife insurers above) and, in the case of forlife insurers, some further provisions as
regards performance measurement andfees (again, see 2.4.7(d) above) may wellalso be included;(iii) where acting for a pension trustee,requirements to invest in accordancewith the Private Scheme Investment
Regulations and with a view to giving
effect to the principles containedin the SIP so far as reasonably
practicable (see 2.2.10(b)(v) above);363(c) fiduciary duties owed to Asset Owners364
see 1.17 to 1.23 above (which may be
modified by the relevant IMA); and(d) the duty of care owed to the Asset Ownersee 1.43 to 1.58 above (which again may be
modified by the IMA365).

(b) primary and delegated legislation,
including:
(i)

(ii)

the FCA requirements discussed in
1.21, 1.31, 1.42 and 1.45 above andthe FCA requirements that a firmmust take reasonable care to organiseand control its affairs responsiblyand effectively, with adequate risk
management systems (PRIN 2.1.1R(3));
FCA COBS rules (see, for example, 1.45
above), including requirements on an
Investment Manager aimed at ensuring
the investment mandate and theinvestment decisions made under it aresuitable for its client.360 This requires it
to obtain appropriate information fromthe client concerning:361•

the client’s financial situation,
including its ability to bearlosses; andthe client’s investment
objectives, including its risk
tolerance.

6.3

6.4

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An Investment Manager must disclose
publicly the nature of its commitment to
the Stewardship Code or its alternative
arrangements.366 It is also subject to the
obligations described in relation to an
AFM at 3.3.3 to 3.3.5 above.

European Union

The FCA has now published (in CP21/17)
its proposals for publicly available,annual entity level TCFD disclosures for
Investment Managers (see 2.3.8 above,
including as regards thresholds andtiming) and, upon request, portfoliolevel disclosures. These are intended forinstitutional clients that are themselves
subject to climate- related financial
disclosure obligations. Firms would be
required to provide product or portfoliolevel disclosures to those clients once

South Africa

FranceJapan

Netherlands

United Kingdom
United States

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REFERENCES

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in each 12-month period, upon request
specifying a calculation date no earlier
than 1 July 2023. Where an Investment
Manager does not have the informationnecessary to provide portfolio disclosures,
they should use proxies and assumptions,and briefly explain the methodologies,
context and limitations.
6.5

Legal obligations with respect to
Sustainability Impact
Financial materiality and investment horizons
6.7

The PLSA/Investment Association joint
steering group referred to in relation to
2.2.9(b)(v)(D) above met for the first time
early in January 2021 to consider a range
of issues aimed at strengthening therelationship between Asset Owners andInvestment Managers, including:(a) the proactive steps Investment Managers
can take to understand and deliver theirclients’ stewardship priorities;(b) the role Investment Managers’ disclosures
play in the information flow between
Investment Managers and Asset Owners intheir approach to stewardship, including
how these disclosures demonstratethat the stewardship and investment
approaches have been aligned with theAsset Owner’s wishes;(c) the role of Asset Owners in ensuring
stewardship plays a key role in theirapproach to manager selection andongoing performance and oversightassessment; and(d) the role the contractual relationship andnon-contractual arrangements can playin embedding a long-term focus and clear
stewardship expectations, including aconsideration of model mandates.

6.6

491

Further industry guidance on these points,
which seems likely to have relevanceto life insurer Asset Owners too367, cantherefore be expected soon.

(b) “the index funds [Vanguard manages] on
your behalf are practically permanent—
structurally long-term—owners of thecompanies in which they invest.….We
start with the premise that our equity
index funds invest in just about every
public company, and every industry,
practically forever. With this indefinite
horizon, our funds must focus on how
companies are setting themselves up for
success today, next year, and well into the
future”.372

6.8

An Investment Manager is an agent so the
IMA it has with its Asset Owner provides
the framework which shapes most of theother legal requirements to which it issubject.368 Thus, the investment objective
and investment policy set by that IMA
provide the yardstick against which
financial materiality is to be judged. The
CFRF 2020 Guide is relevant to Investment
Managers as well as to insurers, although
investment-related risks will be clients’risks, rather than those of the Investment
Manager. The FCA will nevertheless expect
appropriate understanding of each client’s
risk appetite including time horizons.369
The approach to risk is circumstancespecific and it is difficult to generalise.
It is clear, however, that climate change(by way of example of a sustainabilityrisk) will often be a material risk to theachievement of a client’s investment
objective.370
Despite the potential incentives to focus
on short term performance discussed inPart B.4, it seems clear that at least some
Investment Managers are taking a longterm view on value creation and that thisunderlies, in particular, their stewardship
activities. For example:(a) “BlackRock takes a long-term perspective
in its investment stewardship programme
informed by two key characteristics of ourbusiness: the majority of our clients aresaving for long-term goals so we presume
they are long-term shareholders, andthe majority of our equity holdings are
in indexed portfolios so our clients are,by definition, long-term and locked-in
shareholders”371;

6.9

Each Investment Manager will havea number of clients; the investment
objectives those clients have set for theInvestment Manager will not align witheach other and may even conflict (see 1.21
to 1.23 above). As regards investment anddivestment, it is feasible for a manager
to take different approaches - by way
of example, it may decide to divest its
active clients from a particular portfolio
company, whilst at the same time being
obliged to retain (or depending on indexweighting, even increase) its holdingof shares in that portfolio company inpassive portfolios it manages. As regards
stewardship, a divided approach may
be more difficult in practice and isobviously less effective. As noted above,it is unusual for a client to include
stewardship-related provisions in its IMA
and an Investment Manager is requiredby FCA rules to disclose its approachto stewardship. It appears common for
Investment Managers to take a firmwide approach to stewardship activity
across all of the portfolios they manage.
It seems reasonable to assume that thisis on the basis that to do so is in the bestinterests of its clients generally and that
the Investment Manager has satisfied
itself that its stewardship approach is not

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

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inconsistent with its obligations underits IMAs, including their investment
objectives.373

using portfolio climate monitoring andanalysis tools.” In other words, Investment
Managers are increasingly looking atclimate risk as a sustainability risk andnot simply as an idiosyncratic risk and areusing their analysis, where they consider
the results are material to achieving theinvestment objectives the Asset Owner has
set for them, to inform investment and, inparticular, stewardship decisions.

Legal requirements to use investment powers to IFSI
6.10

6.11

492

An Investment Manager should identify
considerations relevant to its investment
decision-making against the background(primarily) of the IMA it has entered intowith the Asset Owner. In order to fulfil
its duty of care, an Investment Manager’s
decisions should always take care in its
identification of relevant matters and take
into account any matters it has identified
as financially material to those decisions.
Taking climate change as an example, the
CFRF 2020 Guide374 notes that investment
decisions to which climate change isrelevant should factor in both current andforward-looking climate risk assessments.
It goes on to indicate that it should beconsidered as part of company, sectorial
and underlying analysis because “climate
risks can be relevant to a variety of sectors
and can directly impact equity values,
credit spreads, commodities, interest
rates, foreign exchange, bond prices andall other associated market parameters.”
It also explains that, as a matter ofpractice, “climate metrics and evaluation
are increasingly included as part ofmonitoring of a portfolio of assets
or securities. This attempts to take a
step away from asset level monitoringand provide a view on the portfolio asa whole. This evaluation tends to bequantitatively driven and raises flags forfurther qualitative analysis rather thanassessing whether a portfolio is withina defined limit or set of parameters toinvest within…The value of stewardshipand voting activities are maximised once
investors have first identified red flags

6.12

discretion to pursue a strategy of making
or disposing of investments to achievesustainability impact for a non-financial
reason.
Legal requirements to steward for IFSI
6.14

As noted in relation to each Asset Owner(see 2.2.35, 2.3.17, 2.4.20 and 2.4.28
above) it seems more likely that an
Investment Manager will conclude thatthe tool (if any) which it is appropriate
to deploy in relation to a sustainability
impact risk is stewardship, coupled withselective investment and disinvestment,
rather than purely investment anddisinvestment.375

Legal freedom to use investment powers to IFSI
6.13

We have explained above that, where an
Investment Manager concludes that afinancial factor is material to a scheme’s
investment objective, it must take thatfactor into account. This section deals
with non-financial factors. A sustainability
factor will fall within this category where
it is not considered by the Investment
Manager to be a material financial factor
in relation to the investment objective
its Asset Owner client has set for it. The
extent to which an Investment Manager
will be able to take account of nonfinancial factors in these circumstances
will be largely dependent upon theterms of the IMA. Where this permits
the Investment Manager to do so, oreven sets a non-financial investment
objective, it will be permitted or required
to do so. Where the IMA is silent, an
Investment Manager would not have legal

6.15

As noted in 1.39 above, an Investment
Manager has a duty to take into accountmatters which it has, or ought to have,identified as financially material to its
investment-related decisions. Where it
identifies a sustainability factor that ismaterial in this way, it must then decide,what (if any) action to take in respect of
it. The Investment Manager may wellconclude that stewardship activities inrelation to one376 or more companies is
an appropriate way to seek to minimise
the relevant risk to its Asset Owners’
portfolios; see for example, “a significant
challenge for asset managers with index
strategies invested in thousands oflisted companies globally is to provide
active oversight of their holdings…
our stewardship program identifies aseries of strategic priorities designed toenhance the quality and define the scopeof our stewardship activities for the year.
Identifying these priorities enables us toplan and actively focus our engagement
efforts on thematic ESG and sectorspecific issues that are important to ourclients”.377
It is clear from the statements quoted at
6.8 above that the relevant Investment
Managers regard the ability to engage
with portfolio companies as a critical toolin their armoury in achieving long term
value in the passive funds they manage.
The same is true of active investors. For
example:ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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GLOSSARY
REFERENCES(a) “as an active investor for many years, we
believe that robust engagement and voting
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by institutional investors is critical to thehealth of financial markets and long-termvalue creation. This is particularly so in
principles-based, “comply or explain”
regimes, whose effectiveness requires
active involvement by investors to holdboards of listed companies to accountfor the fulfilment of their stewardship
responsibilities…As a long-term investor,
we aim to build an understanding of thefundamental factors shaping the risks
and opportunities of the companies weinvest in. We believe that ESG issues
can have a material impact on company
performance and on the economy as awhole, and that robust ESG managementby companies is an integral part of goodrisk management”378;(b) “active asset managers with the deep
investment resources are required tounderstand how sustainability issues
intersect with financial performance…
Our role as fiduciaries extends beyond
achieving our clients’ risk-returnobjectives. It also requires a holistic
approach to stewarding our clients’capital. Our Global Governance Principles
provide a framework for stewardship,clearly setting out our expectationsof company management. They arefounded on the belief that long-term
shareholder value is enhanced througha more comprehensive assessment of
stakeholder management. This includes
both how a company invests in its humancapital – including employees, suppliers,
their customers, and the community – aswell as its approach to natural capital,
including its dependency and use ofnatural resources and its approach to
managing climate change risk. Our
regular dialogue with companies andsovereigns means we are well positioned493

to advance sustainability imperatives
via purposeful engagements, outcomeoriented voting, and asset allocation”379;
and(c) The Investment Association has
committed to developing guidance for
its Investment Manager members on
governance, culture and incentivisation of
stewardship.380
Legal freedom to steward for IFSI
6.16

As explained above, this section deals with
non-financial factors. A sustainability
factor will fall within this category where
it is not considered by the Investment
Manager to be a material financial
factor in relation to its investmentrelated decisions. See 6.13 above for ourconclusions.

Public policy engagement with a view to IFSI
6.17

In 4.1.1, we have explained that unless,unusually, a person (in this case, an
Investment Manager) is engaging in public
policy work as a representative on behalfof one of more clients, (in which casepolicy work is better seen as a particularform of stewardship), the duty which islikely to be key is the “no conflicts” rule.
This requires consideration of the cost (ifany) to the Investment Manager’s clients
and whether the proposed public policyrelated activity is likely to result in any
adverse consequences for the portfolios
which the Investment Manager manages
contrary to the terms on what it has been
appointed. Public policy engagement is apotentially important, and well used, toolby Investment Managers381.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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7.

LEGAL LIABILITY TO THIRD PARTIES FOR THE NEGATIVE SUSTAINABILITY IMPACT OF PORTFOLIOCOMPANIES, DISCLOSURE-RELATED AND REPUTATIONAL RISK

7.1

This section considers the extent towhich, regardless of the legal rules
under which it is required to operate
and its constitution, an Asset Owner
could be legally liable to third parties
for the negative sustainability impact
of portfolio companies, and whether an
Investment Manager could also be liablebecause of its role in assisting the Asset
Owner to invest in the relevant portfolio
company and steward its investment. It
also looks briefly at some other kinds ofsustainability factor-related litigation risk.

7.2

Asset Owners

7.2.1

It is possible that Asset Owners could
be found to have criminal or civil
liability to third parties for the negative
sustainability impact of portfolio
companies.

the activities of the portfolio company.
However, this is not typical of the Asset
Owners considered in this Report.
7.2.3

7.2.4

Criminal liability
7.2.2

494

It is unlikely that an Asset Owner would
be held criminally liable for the negative
sustainability impact of a portfolio
company. Exceptionally, primary criminal
liability might exist where an Asset Ownerhas direct involvement in the portfolio
company’s activities or operations,and where those are determined to becriminal under the relevant legislation(for example, for unauthorised or harmful
deposit of waste, or illegal discharges toair, land or water), but the usually arm’s
length nature of relationships between an
Asset Owner and the activities of portfolio
companies makes such a liability highly
unlikely. The risks would be slightly
higher if an Asset Owner or a director
nominated by it had close day-to-day
involvement in, and direction over,

It is possible that direct clean-up/
remediation liability can be incurred
where a person causes or “knowingly
permits” an incident which leads topollution, which can result in criminal
liability; however, there would have to besome direct intervention at operational
level in order for an Asset Owner to be
so liable; once again we consider suchliability unlikely.382

company in respect of its subsidiary’s
activities. These include where a parent
company issues “[g]roup guidelines aboutminimising the environmental impact
of inherently dangerous activities …
contain[ing] systemic errors which, when
implemented as of a matter of course by aparticular subsidiary, then cause harm tothird parties”.383 In such circumstances, aparent company could be held liable forharm caused by a subsidiary.
7.2.7

Secondary liability is also theoreticallypossible, for example, if a nominee
director appointed by an Asset Ownerassumed managerial responsibility
over relevant activities of the portfolio
company, and consented to, or connived
in, an illegal act or omission (such aspollution of a waterway, or operation of aregulated facility without the appropriate
environmental permit). However, only
exceptionally would an Asset Owner
exercise the required level of engagement
in a portfolio company’s operations to
attract this type of liability.

Civil liability
7.2.5

7.2.6

It is possible that, in certain limited
circumstances, an Asset Owner could
be found to have a duty of care towards
individuals harmed by portfolio
company’s actions (or inaction) which
result in a negative sustainability impact,i.e. liability in negligence. The standardof care applicable to a particular scenario
will depend heavily on the facts.

However, the likelihood of liability innegligence for a minority shareholder(as an Asset Owner would generally be)
is fairly remote: not only must the harmcaused by the negligent act or omission
have been reasonably foreseeable, butthere must be sufficient proximity
between the parties (i.e. between the Asset
Owner and the portfolio company whichcauses harm, which would likely require a
degree of direct involvement or operation
control on the part of the Asset Owner),and it must be “fair, just and reasonable”
to impose liability to a third party on the
Asset Owner.384 We consider it unlikelythat these requirements would be met
in relation to the usual activities of an
Asset Owner of the type described in thisAnnex.385

7.3

Investment Managers

7.3.1

It is even less likely that an Investment
Manager, as agents of its client Asset
Owners, would be found to haveliability to third parties for the negative
sustainability impact of portfolio
companies.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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GLOSSARY
REFERENCES

There are a number of scenarios in which
a duty of care could be owed by a parent
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Criminal liability
7.3.2

7.3.3

7.3.4

As for an Asset Owner, an Investment
Manager might have primary criminal
liability where it has direct involvement
in a portfolio company’s activities
or operations, and where those aredetermined to be criminal under the
relevant legislation. However, Investment
Managers would not generally have thenecessary degree of direct involvement for
criminal liability.

Asset Owner would in practice be borne by
the Asset Owner (absent fraud or similaregregious conduct by the Investment
Manager).
7.4

Disclosure-related risk

7.4.1

Most types of Asset Owner covered in thisAnnex and also Investment Managers are
required to make an increasing number of
essentially public disclosures about theirinvestment and stewardship activities,
including potentially any sustainabilityrelated aspects of those activities. These
disclosures have at least two broad
purposes – first, they force the disclosing
entity to consider whether it has in place
the appropriate governance and related
arrangements in relation to the mattersabout which it is making disclosures386
and secondly, they aim to provide theAsset Owners themselves (in the case of
disclosures by Investment Managers) andthe Beneficiaries of the relevant Asset
Owner (in the case of disclosures by therelevant Asset Owner387) with decisionuseful information.

As an Investment Manager would not bea member of the company, it would not
be possible for them to have secondary
liability (as described at 7.2.4). Liability
as an accessory is theoretically possible
in very narrow circumstances where theInvestment Manager can be demonstrated
to have aided, abetted, counselled or
procured the commission of an offence(e.g. through a nominee director
appointed on its behalf) but is highly
unlikely.
It is also hypothetically possible for an
Investment Manager to incur direct cleanup/remediation liability for contaminatedland under Part 2A Environmental
Protection Act 1990, which can resultin criminal and civil liability. However,the degree of required knowledge andoperational involvement makes liability
unlikely.

7.4.2

Civil liability
The civil liability position is similar tothat for Asset Owners, save that theInvestment Manager will be further
removed from any relevant negligent
conduct and therefore less likely to befound liable. It would be typical for the
IMA to include indemnification provisions
such that the risk of any such liability
incurred in fulfilment of its duties to the
495

7.4.3

related decision-making, they docontribute to the transparency of it, thus
potentially attracting increased scrutiny
from regulators and Beneficiaries (or an
Investment Manager’s clients).
7.4.4

7.5

Other reputational and regulatory risks

7.5.1

There is currently a developing trendof complaints being made by NGOs
to regulatory bodies, such as on
the basis of alleged breaches of theOECD Guidelines.389 Such complaints,
usually allegations of non-disclosure orcontribution to environmental damage,are not part of a legally binding process
but have the potential to cause significant
reputational damage, and the usualoutcome is for the parties to reachagreement on addressing the conduct
complained of, which often requires
action on the portfolio company’s part.
It is also possible that complainants insuch actions could use any information
disclosed as part of those processes
to commence or inform subsequent
litigation.

For the disclosing entity, this gives riseto additional risk. For example, those
disclosures could be inaccurate at thetime they are made or the entity might
subsequently slip below the standards it
has set itself in its disclosures, or perhaps
it could become clear that the discloser is
not taking a consistent approach acrossits activities.388 At minimum, these kindsof failure give rise to reputational risk forthe entity in question and may, in serious
cases, lead to regulatory intervention
or possibly to liability for negligent
misstatement.
Further, although disclosures of this kind
do not directly impact on an Asset Owneror Investment Manager’s investment-

It is worth noting that disclosure-related
claims tend to be brought by strategic
claimants (such as environmental law
charities and other non-governmentalorganisations) who are more interested indriving change than an award of damages.
This can change the dynamics of thelitigation. Strategic claimants are more
likely to litigate to achieve settlements inwhich the defendant agrees to take action
to decrease its negative sustainability
impact, which may well go beyond what
a court could order. For an example ofstrategic claimants in action, see thedescription of the settlement in McVeigh v
Rest (at 2.2.33 above).

7.5.2

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

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REFERENCES

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the OECD Guidelines in other jurisdictions
have already been asked to consider
complaints referred in relation to alleged
breaches of the Guidelines by institutional
investors.390 However, to date no suchcomplaints have been made against
institutional investors in the UK.
7.5.3

We also note that, in retail markets, massretail claims have become a potent force
in the financial sector and beyond (forexample, in relation to vehicle emissions).
So far this has not been the case in areas
directly related to sustainability.

ACKNOWLEDGEMENTS

Edmund Barber, Olivia Carrington, Gareth
Davies, Rachel Duffy, Lisa Eger, Morag Elwis,
Angela Evans, Laura Feldman, Abdullah Geelah,
Tom Howard, Shona Hughes-Daly, Gregory
King, Priti Lancaster, Charles Magoffin, Martin
McElwee, Emma Rachmaninov, Tom Rhodes,
Christopher Simpson and Annabel Sykes

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

496

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Appendix 1: UK annex glossary

ACKNOWLEDGEMENTS

Term

Description

2014 Reporta report by the Law Commission on the “Fiduciary Duties of Investment Intermediaries” (Law Com No 350)

EXECUTIVE SUMMARY

AFM

authorised fund manager

BEIS

Department for Business, Energy and Industrial Strategy

CJEU

Court of Justice of the Eruopean Union

CFRF 2020 Guidea guide by the Climate Financial Risk Forum entitled “Climate Financial Risk Forum Guide 2020” (June 2020). The summary to the guide was co-produced by the FCA and PRA.

chosen funda pension fund within a scheme (other than a default fund) in which scheme members may choose to invest their funds

default funda pension fund within a scheme in which scheme members’ funds are invested in the absence of any choice by the member

DWP

Department for Work and Pensions

DWP Climate Risk 2021
Consultation

A policy response and consultation by the DWP on “Taking action on climate risk: improving governance and reporting by occupational pension schemes”

EU Impact Assessment

Commission Staff Working Document Impact Assessment Accompanying the document Proposal for a Regulation of the European Parliament and of the Council on theestablishment of a framework to facilitate sustainable investment and Proposal for a Regulation of the European Parliament and of the Council on disclosures relating tosustainable investments and sustainability risks and amending Directive (EU) 2016/2341 and Proposal for a Regulation of the European Parliament and of the Council amending
Regulation (EU) 2016/1011 on low carbon benchmarks and positive carbon impact benchmarks

FCA

Financial Conduct Authority

FRC (to become ARGA)

Financial Reporting Council (which is to be replaced by the Audit, Reporting and Governance Authority)

FSMA

Financial Services and Markets Act 2000

GAA

governance advisory arrangements, which may be entered into by pension providers operating smaller and less complex schemes instead of establishing ICGs

CanadaIGC

Independent Governance Committees, which must be established and maintained by firms operating workplace personal pension schemes

China

Investing with Purposea report by the Treasury-led Asset Management Taskforce on “Investing with Purpose: placing stewardship at the heart of sustainability growth” (November 2020)

European UnionISS

the investment strategy statement which is required by Regulation 7 LGPS Investment Regulations

FranceKIID

a Key Investor Information Document, required to be produced in respect of certain packaged retail investment and insurance products (e.g. UCITS)Japan

Law Commission

a statutory independent body created by the Law Commissions Act 1965 to keep the law of England and Wales under review and to recommend reform where it is needed

LGPS Authority

the administrative authority responsible for maintaining and investing a fund within the LGPS (SI 2016/946)

LGPS Investment Regulations

Local Government Pension Scheme (Management and Investment of Funds) Regulations 2016

PCRIG Guide 2020

“Aligning your Pension Scheme with the TFCD Recommendations” published by the Pensions Climate Risk Industry Group (January 2021)

United Kingdom

PLSA

Pensions and Lifetime Savings Association

United States

PRA

Prudential Regulation Authority

Private Scheme Investment
Regulations

Occupational Pension Schemes (Investment) Regulations 2005 (SI 2005/3378)

OEIC

an open-ended investment company, as defined in section 236 FSMA

497

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ANNEXESJURISDICTION REPORTS

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BrazilNetherlands

South Africa

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REFERENCES

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Term

Description

Section 172

section 172(1) Companies Act 2006

SIP

the statement of investment principles required by section 35(1) Pensions Act 1995

SS3/19supervisory statement by the PRA on “Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change” published in April 2019TPR

The Pensions Regulator

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REFERENCES

498

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12

3The Pensions Schemes Act 2021 did not receive Royal Assent until
11 February 2021, but it is sufficiently important that it and relevant
matters flowing from it have been included as have statutory
instruments to be made under the powers its creates. The EU’s
Sustainable Finance Package, the FCA’s CP 21/17 on enhancing
climate-related disclosures by asset managers, life insurers and FCAregulated pension providers and CP21/18 on enhancing climaterelated disclosures by standard listed companies and the BEIS’
March 2021 Consultation on requiring mandatory climate-related
financial disclosures by publicly quoted companies, large privatecompanies and limited liability partnerships have been mentioned
for similar reasons.
Very broadly, with limited modifications to make it operate properly
in a UK-only context, EU legislation currently of direct effect in the
UK was “onshored” at 11.00pm on 31 December 2020 – section
3 European Withdrawal Act 2018 (as amended by section 25
Withdrawal Agreement Act 2019) (EUWA). The interpretation ofretained EU law (that is broadly onshored EU law, plus EU lawderived domestic legislation) is dealt with in EUWA. For EU law
which has been onshored without modification, for so long as it
remains in force, CJEU case law and general principles of EU law (asin force immediately prior to onshoring) apply until a relevant UK
court departs from them (there are rules about which courts may
make this decision and they may only do so in circumstances where
they would depart from UK case law). Post 31 December 2020 CJEU
decisions are persuasive, but not binding. As regards non-legislative
EU materials, the FCA and PRA have confirmed that generally theseremain relevant unless they have indicated otherwise. TPR has madeno statement in relation to the continuing status of such materials.
Although, even in this case, as the CFRF 2020 Guide summary
acknowledges “The understanding of [climate change] risks isrelatively immature and poses unique challenges, but the need toaddress them is pressing.” Climate change risk encompasses two
separate primary risk factors - physical risk and transition risk. Thereis also a third - liability risk - which arises from parties who havesuffered loss or damage from physical or transition risk factors andseek to recover from those they hold responsible (see SS3/19 page 2).

4

SS3/19 page 3 “Financial risks from climate change will beminimised if there is an orderly market transition to a low-carbon
world, but the window for an orderly transition is finite and closing.”

5

See the Taskforce on Nature-related Financial Disclosures https://
tnfd.info (accessed at 14 July 2021) and “the economics of diversity:
the Dasgupta review” (February 2021).

6

See Part A 1.1.3(b) of the Report. Stewardship covers a number ofpossible activities of varying cost and intensity.

7

We have used the expression “investment goal” to denote the overall
financial objective which an Asset Owner is pursuing in the exercise
of its investment-related powers and investment objective to denote
an objective it has set for an Investment Manager. Save in the caseof a mutual fund, the two will not necessarily be the same thing; apension fund and an insurer may well have a number of different
investment portfolios with different investment objectives, which will
be consistent with its investment goal.

8

Some investment consultants provide a service referred to as fiduciary
management (or implemented consulting) in which their role extends
beyond an advisory one to one where investment decisions are made.
Some Asset Owners use a stewardship service provider.

9

In an investment decision context, this includes through use of apooled product. The main issues a collective approach gives rise toare covered in 3.1.19 to 3.1.22 below.

10

Occupational pension scheme trustees would need to obtainappropriate authorisation under the FSMA to carry out day-to-day
management of the trust’s asset themselves (see Article 37 of the
Financial Services and Markets Act 2000 (Regulated Activities)

499

Order 2001 (SI 2001/544) and Article 4 of the Financial Services
and Markets Act 2000 (Carrying on Regulated Activities by Way ofBusiness) Order 2001 (SI 2001/1177)) and, as such, typically they do
not make day-to-day decisions or obtain such authorisation. It would
not be unusual for an insurer to delegate management of its assets
to a member of its corporate group, but that Investment Manager
will invariably be authorised so as to be permitted to manage assets
for clients which are not group members. Pension scheme trustees
might instead structure their investment portfolio as a unit-linked
insurance policy; this is not delegation but nevertheless adds alayer of complexity. Alternatively, they might invest only in collective
vehicles (mutual funds or a pension-specific pooled fund, using anover-arching balancing agreement with an Investment Manager).
11

Many mutual funds managed by UK-based Investment Managers are
established in Ireland or Luxembourg. For example, “three quartersof assets in [UK managed] overseas domiciled funds are managed
for funds domiciled in Ireland and Luxembourg” (“Investment
Management in the UK 2019-2020” survey, page 14).

12

In its “Guide to Investment Governance for DC schemes” (July 2019)
TPR refers to “investment beliefs” and says “you may find it helpful todevelop and maintain a set of beliefs about how investment markets
function and which factors lead to good investment outcomes.
Investment beliefs, supported by research and experience, canhelp focus your investment decision-making and make it more
effective. If you do this, your investment strategy should then reflect
those beliefs.” For DB schemes, see TPR Guide “Investing to FundDB”. Trustees’ investment beliefs should not be confused with theirpersonal (i.e. ethical or moral) beliefs.

13

For example, investment restrictions and risk limits.

14

The Stewardship Code was first published in 2010 to improve longterm returns to beneficiaries by enhancing the quantity and qualityof engagement between investors and companies. It was introduced
as a result of Sir David Walker’s Review of corporate governance in
UK banks and other financial industry entities. The latest version tookeffect in 2020.

15

16

17

18

According to the FRC website, first applications to become
signatories to the 2020 Stewardship Code closed on 31 March 2021
for Investment Managers and on 30 April 2021 for Asset Owners.
The FRC will evaluate the reports they have submitted and notify
organisations of the outcome of their application shortly before thefirst list of signatories, which will include successful applicants, ispublished in late summer 2021.

they can adapt their businesses in response.”
19

20

There are some limitations on this: see 6.2 below.

21

Bristol and West Building Society v Mothew [1998] Ch 1 at 16 and18. Unfortunately, as the 2014 Report says at paragraph 3.11 “theterm ‘fiduciary duty’ means different things to lawyers and nonlawyers, even lawyers use the term in different ways.” In chapter 62
of Pensions, Contracts and Trusts: Legal Issues on Decision Making(2020) David Pollard discusses this further and seeks to reconcile
some important, but apparently contradictory, cases.

22

Paragraph 1.17.

23

Paragraph 1.20 of the 2014 Report usefully describes them as “legal
polyfilla”, moulding themselves around other structures to plug thegaps. They will, for example, impact, and be impacted by, the termsof any relevant contractual relationship between the parties and, wewould suggest, any applicable statutory duties.

24

FCA rulebook PRIN 2.1.1R(8). The FCA rules use “customer” as acollective term for “professional clients” and “retail clients”. The
expression “client” includes eligible counterparties, as well as“customers.” See FCA SYSC 10 and PRIN2.1.1 R(8) for rules on
conflicts of interest.

25

Where fiduciary duties arise and PRIN 2.1.1R(8) applies, therequirements of each, which are not identical, must be complied with.

26

These would include material diminution in income from, or to themarket value of, one or more investee companies.

27

See S & P Global “Lights out for coal” https://www.spglobal.com/en/
research-insights/featured/coal (accessed at 14 July 2021)

28

CFRF 2020 Guide, Summary chapter, page 3.

29

Paragraph 3.44 et seq. “Fiduciary powers are a class of limited
powers. Ordinarily a fiduciary obligation connotes a duty of loyalty.
In this context, the significance of the fiduciary obligation is that thedonee of a fiduciary power owes a duty to the objects of the power
to consider from time to time whether and how to exercise it andthey have various remedies open to them if the donee does not orcannot do so. He is not bound to exercise it merely by virtue of its
being a fiduciary power: the duty is to consider its exercise…Generally,a fiduciary power cannot be exercised, or be left unexercised, by thedonee for his own benefit…” Lewin on Trusts (20th Edition, 2020), 28018. “…a power may be conferred on a person in order that it should
be used, if at all, to perform vicariously a task for the person who
conferred the power: to achieve an end within a range of outcomesdesired or anticipated by the donor of the power, but which involves
making a selection or decision which at the time of the creationof the power the donor is unable or unwilling to make. This type of
power will be fiduciary: the holder of the power must stay within its
terms, like the holder of a non-fiduciary power, but he will also be
accountable for his conduct as regards the power in other ways…”
Snell’s Equity (34th edition, 2019 ), 10-009. As regards public policy
engagement, an Asset Owner or Investment Manager will notnecessarily be exercising a fiduciary power (see further 4 et seq and6.17 below).

The Asset Management Taskforce was established in 2017 toencourage greater dialogue between the government, the industry
and the FCA. It is led by the Treasury and administrative support
is provided by the Investment Association. The two working
groups which produced the report included representatives frominvestment management firms, pension funds, company directors
and investment advisers as well as observers from the FCA, FRC,
BEIS, DWP, TPR and the Treasury.
TPR has power to issue Codes of Practice containing practicalguidance regarding the standards of conduct and practice of those
who exercise functions under the pensions legislation. They areadmissible in evidence in legal proceedings and, if any provisionappears to the court or tribunal concerned to be relevant to anyquestion arising in the proceedings, it must be taken into account– section 90 Pensions Act 2004. As well as publishing its own
guidance, FCA has a process for recognising industry guidance.
For example, page 5 of the summary to the CFRF 2020 Guide says
“this…guide aims to help financial firms understand the risks andopportunities that arise from climate change, and provide support
for how to integrate them into their risk, strategy and decisionmaking processes. As part of this, the guide considers how firms canplan for the impact of climate policies over different time horizons
and assess their exposure to climate-related financial risks so that

For convenience, regulatory rules made by the FCA, which coversimilar ground to judge-made law and which apply to certain
Asset Owners and Investment Managers, are also mentioned in thissection. Any breach of regulatory rules may result in action by theregulator. In relation to some regulatory rules, but notably not FCA’s
principles for businesses or PRA’s Fundamental Rules, a “private
person” (as defined in Regulation 3(1)(b) of the Financial Services
and Markets Act 2000 (Rights of Action) Regulations 2001 (SI2001/2256) has a direct right of action in respect of breach against
the relevant regulated firm. A “private person” need not be a client of
the regulated firm in question.

30

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As David Pollard notes in chapter 10 of Pensions, Contracts andTrusts: Legal Issues on Decision Making (2020) this test is easy

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to state, but can, in practice, be difficult to apply and see also its
chapter 16 as regards the determination of a decision maker’s
purpose.
31

Paragraph 4.35.

32[1985] Ch 270.

33

Paragraph 6.15.

34

EWHC 448 (Ch) [2015] PLR 239 page 7.

35

Regulation 4(2)(a) – reflecting article 19(1)(a) of the IORP II, which
provides that “the assets shall be invested in the best long-term
interests of members and beneficiaries as a whole.”

36

In their March 2014 joint guide to the regulation of workplacedefined contribution pensions FCA and TPR said “FCA’s job toensure that firms that provide contract-based schemes treat theircustomers fairly. In the same way, [TPR] expects trustees to act in
the best interests of their scheme’s beneficiaries. In both cases it
is clear who is responsible for considering the interests of scheme
members…the regulators do have the same expectations for scheme
quality and member outcomes.” As the court noted in Harries v
Church Commissioners [1992] 1 WLR 1241 at 1247 trustees “mustnot use property held by them for investment purposes as a means
for making moral statements.” In “The Short-form Best Interests
Duty – Mad, Bad and Dangerous to Know: Part 1 – Background,
Cowan v Scargill and MNRPF” and “Part 2 – the problems and asuggested better formulation”, Trust Law International, Vol. 32, No.
2, 2018 David Pollard suggests that a clearer formulation than “bestinterests” is “trustees…must, broadly, exercise their powers within
the terms of the trust…and for a proper purpose and for what they
consider, in good faith, to be most likely to promote the success ofthe trust.”

37

38

39

40

41

500

42

Paragraph 6.81. However, in paragraph 6.83 the Law Commission does
go on to say “In DC schemes, members bear both the benefits andthe risks of the investment decision and should therefore be entitledto make informed ethical choices. We think that where the trusteesof DC schemes are faced with members’ clearly articulated views theyshould attempt to provide a suitable choice of funds.” Principle 6 of
the Stewardship Code envisages that a signatory will take account ofclient and beneficiary needs and communicate to them the activities
and outcomes of their stewardship and investment. This includes

Or, indeed, what will promote the success of the mutual fund or
insurer (see 1.19 above for the conflicts of interest requirements
which must also come into play in making this judgement).

53

Re Tempest (1886) 1 Ch App 485 at 487 - 488.

54

Paragraphs 3.59 to 3.61 of the 2014 Report explain these principles
further and, in particular, that this is not a mechanistic process, but ageneral requirement of fairness.

EXECUTIVE SUMMARY[1948] 1 KB 223.

44

See paragraph 3.64 of the 2014 Report. Though trustees (inparticular pension scheme trustees) have long been recognized
as being obliged when exercising discretions to give properconsideration to relevant matters and not consider matters which
are irrelevant.

55

FCA rulebook PRIN 2.1.1R(6). As noted at 1.23 above, thisrequirement has an important role to play in relation to theresolution of conflicts between the interests of different clients/
beneficiaries. Principle 6 of the Stewardship Code can be seen as
having broadly similar aims.

45[2015] UKSC 17.

56

46

Paragraph 3.33 of Pensions, Contracts and Trusts: Legal Issues on
Decision Making (2020) David Pollard and see further chapters 48
and 49.

Paragraph 3.70. In Pensions, Contracts and Trusts: Legal Issues on
Decision Making (2020) at paragraph 3.29 David Pollard identifies animplied duty of due (or properly informed) consideration, which canbe seen as part of the duty of care.

47

Ibid chapter 50.

57

Henderson v Merrett Syndicates [1995] 2 AC 145 at 193.

48

As noted in the [EU] Impact Assessment (pages 38 and 39) “someentities…do not analyse [ESG] factors, either because they do nothave the tools and the ESG-related knowledge to do it or because
they confuse ESG integration with ethical investing, which implies
accepting lower risk-adjusted returns, which would not be in
the best interest of their clients/beneficiaries.” Paragraph 6.29 of
the 2014 Report says “we hope that we can finally remove any
misconceptions on this issue: there is no impediment to trustees
taking account of environmental, social or governance factors where
they are, or may be, financially material.”

58

PRA fundamental rule 2, which applies to insurers, is expressed in
identical terms.

59

FCA rulebook PRIN 2.1.1R(2) and (9). It seems arguable that an
exercise of investment powers in relation to a unit-linked insurance
fund falls within the second of these requirements. PRIN 2.1.1R(6),covered at 1.42 above is also potentially relevant in this context. As
already noted, FCA guidance will be relevant to assessing whether
the conduct in question falls below that required by the rules (FCA
EG 2.9.4R). It may also be relevant in determining the extent of astandard of care, although the courts have been careful to keep
regulatory rules and tortious duties separate: see Green and Rowley
v The Royal Bank of Scotland [2013] EWCA Civ 1197, and also the
explanation in London Executive Aviation Ltd v The Royal Bank of
Scotland [2018] EWHC 74 (Ch) at 166.

49

50

This requirement is obviously somewhat modified in its application
where the source of the power in question is contractual because
it is generally open to the parties to the contract to modify therequirement and it can, for example, be modified by a trust deed orconstitutional document.
At paragraph 3.31 of Pensions, Contracts and Trusts: Legal Issues
on Decision Making (2020) David Pollard suggests that a more
helpful way of thinking about this requirement is that a decisionmaker must take the relevant decision at the right time, see further
its chapter 69.

ACKNOWLEDGEMENTS

43

PRIN 2.1.1R(6) and COBS 2.1.1R(1)). The latter implements article
24(1) of MiFID, article 17(1) of Directive (EU) 2016/97 of the European
Parliament and of the Council of 20 January 2016 on insurance
distribution ( and article 14(1)(a) and (b) of the UCITS Directive.
The duties under COBS 2.1.1R are owed in a client-by-client basis(contrast the position of trustees). However, an FCA regulated firm isunlikely to have only one client and PRIN 2.1.1R(6) indicates how, asa regulatory matter, they should approach situations where the “bestinterests” of clients are not identical.
Most recently, Adams v Options SIPP UK LLP [2020] EWHC 1229
(Ch) at paragraph 148ff. (appeal on the COBS point dismissed
because argFuments advanced to Court of Appeal differed radically([2021] EWCA Civ 474), but Newey LJ commented at paragraph
126 that “Mr Adams might anyway have struggled to overcome thejudge’s finding that any breach of duty was not causative of loss”).

ordinary public law principles, in particular, the ordinary public lawof reasonableness. They risk challenge if a decision they make is so
unreasonable that no person acting reasonably could have made it.”explaining how they have sought beneficiaries’ views (where they havedone so) and the reason for their chosen approach and how they havetaken account of those views.

51

52

The ministerial foreword to the DWP Climate Risk 2021 Consultation
says “I feel there is still more work to be done to change mind-sets
when I hear “climate risk is likely not the most immediate or criticalrisk for many schemes”…Failing to ensure climate risk, the most
systemic risk facing financial services, is properly considered is – in myview – a failure in trustees’ duty to protect members. Some trustees
may think that these proposals are an overreaction – because they
believe the market has delivered for them over the past decade,because they have seen it ride out “storms” before or because
they wrongly think they have not yet seen any impact of climatechange on their investments. To these trustees I say that the world ischanging, the challenges are changing. You need to change.”60

This issue also comes at trustees of DB schemes from anotherangle; trustees need to be alert to any issue which may impact thestrength of the employer covenant and thus the funding employer’s
continuing support for the scheme. The Braganza case refers to adecision being “irrational”, but others have referred to a decision thatis perverse, arbitrary, capricious or outrageous. The court was notreferring to the economic concept of rational utility maximisation.
Rather it was imposing a minimum objective standard on thedecision-maker’s mental processes with a view to ensuring that thedecision-maker has not abused the power. The test is not the sameas that imposed by the duty of care requirements discussed at 1.43
et seq below.
In “From rationality to proportionality in the modern law” (2014) 44
HKLJ 447 at 449 Lord Carnwath describes the these as imposing
a “very high threshold” in his discussion of the judgment of Lord
Diplock in Council of Civil Service Unions v Minister for the Civil
Service [1985] AC 374, HL.
The guidance issued by the then Department for Communities andLocal Government, “Local government pension scheme: guidanceon preparing and maintaining an investment strategy statement,”
says “Although administering authorities are not subject to trust
law, those responsible for making investment decisions mustcomply with general legal principles governing the administrationof scheme investments. They must also act in accordance with

(1886) 33 Ch D 347 at 355 (applied most recently in Nestle v
National Westminster Bank plc [1993] 1 WLR 1260 at 1267-1268).
However, it is clear that prudence is context-specific but less clear
what it means; the 2014 Report notes (at paragraph 3.72) “there
has been a move away from this traditional language of ‘prudence’.
In 2000, trustees’ duties of care were put on statutory footing in
England & Wales through the Trustee Act 2000…The Act signalled amove towards ‘reasonableness’ as the relevant standard of conduct.”
The Nestle case also suggested that “prudence” may not be themost appropriate expression in the context of a pension fund; “thisprinciple remains applicable however wide, or even unlimited,the scope of the investment clause in a trust instrument may be.
Trustees should not be reckless with trust money. But what theprudent man should do at any time depends on the economic
and financial conditions of that time—not on what judges of thepast, however eminent, have held to be the prudent course in
the conditions of 50 or 100 years before. It has seemed to me
that Mr Nugee’s submissions placed far too much weight on theactual decisions of the courts in the last century, when investment
conditions were very different.” Nestle v National Westminster Bank
[1993] 1 WLR 1260 at 1268. The concept of prudence is, however,used in EU law, for example, IORP II and Solvency II and so broughtback into UK law.

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61(1886) 33 Ch D 347 at 350.

GLOSSARY

62

Paragraph 5.76 which goes on to note that, when investing in longterm equities, this includes risks to the long-term sustainability of acompany’s performance.

REFERENCES

63[1993] 1 WLR 1260 at 1282.

64

Paragraph 6.72 of the 2014 Report notes that “increasing
diversification is not necessarily an unmitigated good and we did notthink that the courts require a portfolio to be diversified to the fullest
extent possible. Instead it is a question of degree in each case, taking

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into account the nature of the scheme.” Paragraphs 6.73 and 6.74
provide further detail.
65

There are supporting statutory duties too generally implementing
requirements of EU directives. For example, Regulation 4(4) and (7)of the Occupational Pensions Schemes (Investment) Regulations
2005 (reflecting article 19 of IORP II) apply as regards private sector
pension scheme trustees. AFMs are also subject to diversification
requirements see (COLL 5.2.3R(1)) and (COLL 6.6.3R(3)(a)).

66

See paragraph 3.80 of the 2014 Report.

67

As to which see [Ch2C of the Report transparency about potential
impact of sustainability factors] and “Moonwalking bears andunderwater icebergs: Hidden risks in markets” speech by Alex
Brazier, Executive Director for Financial Stability Strategy and Risk,
Bank of England at the London Business School Asset Management
Conference (28 April 2018).”.

68

The Pensions Regulator, “Climate Change joint statement.” https://www.thepensionsregulator.gov.uk/en/document-library/statements/
climate-change-joint-statement (accessed at 14 June 2021).

69

See page 52 of the Risk Management chapter of the CFRF 2020 Guide.

70

SS3/19 page 1. See also box 2 page 18 HMG Green Finance Strategy(July 2019). The review of the insurance sector underlying the quoted
comment was carried out in 2015, so the position is likely to have
improved in response to its publication. See 2.4.11 below for a
description of the strategic approach contemplated by the PRA.

71

Bartlett v Barclays Bank Trust Co Ltd [1980] Ch 515 is discussed
further at [3.1.13 and 3.1.14] below as regards stewardship.

72

The circumstances in which ultimate ends IFSI is permissible areconsidered in sections 2, 3, 4 and 6 below.

73

Or where the practice does not stand up to logical scrutiny (seeClerk and Lindsell on Torts, 23rd edition, 2020 at 9-140; Edward
Wong Finance Co Ltd v Johnson, Stokes and Master [1984] A.C.
296; Bolitho v City and Hackney HA [1998] A.C. 232).

74

Nestle v National Westminster Bank Plc [1992] EWCA Civ 12.

75

Page 3 of the Summary chapter. Similarly, paragraph 41 of “Part 1 –Introduction of the PCRIG Guidance” of the PCRIG Guide 2020 says
“trustees should also recognise that market standards are evolving
in this area and that what may be considered ‘prudent’ in relation
to climate-related risks today might no longer meet that standard
in the future, given developing understanding of these risks. Trustees
should keep matters under review.” Recognition that there is notenough credible detailed information on climate financial risk
to support accurate and cost-effective risk-modelling has led theGovernment to fund a Centre for Greening Finance and Investment
https://www.gov.uk/government/news/leeds-and-london-set-tobecome-global-centres-of-green-finance (accessed at 14 July 2021).

76

Chosen because, as the letter says, “we believe that [each of thecompanies in question] faces material headwinds from a move ontoa 2050 net zero pathway.”77

https://www.iigcc.org/resource/investor-expectations-for-parisaligned-accounts/ (which includes the November 2020 specimen
letter and a guide entitled “Investor Expectations for Paris-aligned
Accounts” (accessed at 14 July 2021)). The guide explains “Financial
statements that leave out material climate impacts misinform
executives and shareholders and thus, result in misdirected capital.
Company leaders without correct cost and return information areequivalent to pilots without a properly functioning altimeter. In
extreme cases, companies on the wrong flight path – like planes –can crash.”

78

Recommendation 9 and pages 46 and 47.

79

As is acknowledged by outcomes 3 and 5 of the FCA’s fair treatmentof customers webpage, which is explicitly linked to PRIN 2.1.1R(6) –501

https://www.fca.org.uk/firms/fair-treatment-customers (accessed at
14 July 2021).
80

These requirements do not, on the whole, apply to smaller companies.

81

For example, a 2019 survey of companies’ annual reporting
found that 92% of the FTSE 100 companies reviewed explicitly
identified sustainability risks, but only 31% specifically disclosed
the environmental and/or social impacts of their business (pages.
4-5, PricewaterhouseCoopers, “Purpose and impact in sustainability
reporting: A review of leading UK companies,” November 2019).

82

Section 414C Companies Act 2006; DTR 4.1.8R.

83

These include (broadly) the likely long-term consequences ofcorporate decisions, the company’s impact on the community andthe environment and any reputational risk to the company.

84

For example, paragraph 7A.31, FRC, Guidance on the Strategic
Report, July 2018. See also International Financial ReportingStandards, Standards and climate-related disclosures briefing,
November 2019.

85

Sections 414CA-B Companies Act 2006, which apply to authorised
insurers, whether or not publicly traded.

86

Paragraphs 15 and 20D, Schedule 7, Large and Medium-sizedCompanies and Groups (Accounts and Reports) Regulations (SI2008/410).

87

Section 54, Modern Slavery Act 2015. By way of illustration of how
these disclosures can be used by Asset Owners and Investment
Managers, see the 28 January 2021 letter from the chief executiveof CCLA (an Investment Manager) to the FT, which refers to the“find it, fix it, prevent it” initiative designed to improve engagementwith portfolio companies, based on their annual modern slavery
statements – https://www.modernslaveryccla.co.uk/problem(accessed at 14 July 2021).

88

Many pension funds will have a corporate trustee and so thedecision-makers will, in practice, be the directors of that trustee. In
contrast with insurers, we have not considered the duties of these
directors separately because their powers will need to be exercised
to fulfil the trustee’s own duties.

93

There are no statutory definitions of beneficiary although TPR has
published guidance for the trustees of private sector schemes –https://www.thepensionsregulator.gov.uk/en/document-library/
regulatory-guidance/trustee-guidance (accessed at 14 July 2021).

94

See 2.2.5 below for an explanation. See also the court’s approachin Edge v Pensions Ombudsman [2000] Ch 602) and Re
Merchant Navy Ratings Pension Fund; Merchant Navy Ratings
Pension Trustees Ltd v Stena Line Ltd [2015] EWHC 448 (Ch)which confirmed that it was legitimate for the trustee to take theemployer’s interests into account.

95

96

LR 9.8.6R. See also FCA Policy Statement PS20/17, Proposals toenhance climate-related disclosures by listed issuers and clarificationof existing disclosure obligations, December 2020. Many of the UK’s
largest insurers by assets under management are premium listedcompanies.

89

HM Treasury, “Interim Report of the UK’s Joint GovernmentRegulator TCFD Taskforce,” November 2020.

90“Initial response to the IFRS Foundation Trustees Consultation,”
November 2020. https://www.gov.uk/government/publications/joint-statement-of-support-for-ifrs-foundation-consultation-onsustainability-reporting/initial-response-to-ifrs-foundation-trusteesconsultation (accessed at 14 July 2021). The announcement goes on
to note that this will “promote much-needed integration of financial
and non-financial reporting, within a common architecture”. The
Investing with Purpose report anticipates that, in the future, it may
be appropriate to consider a wider range of sustainability disclosuresfrom private companies and encourages large private companies
to have regard to the ongoing dialogue about harmonisation ofsustainability frameworks
The International Organization of Securities Commissions (IOSCO)
has established a Board-level Taskforce on Sustainable Finance,with the aim of coordinating global efforts to advance the market
for sustainable finance. One particular area of focus is issuers’
sustainability- related disclosures (IOSCO FR04/2020 Sustainable
Finance and the Role of Securities Regulators and IOSCO page 29)..

91

92

HM Government, “Green Finance Strategy: Transforming Financefor a Greener Future,” July 2019. https://assets.publishing.service.
gov.uk/government/uploads/system/uploads/attachment_data/
file/820284/190716_BEIS_Green_Finance_Strategy_Accessible_Final.
pdf (accessed at 14 July 2021). As regards timing see the Regulatory
Initiatives Grid (May 2021) published by the FCA. It is unclear
whether and to what extent the non-disclosure related elements ofthe EU Sustainable Finance Package will be implemented in the UK.

97

98

99

There appears to be academic consensus that their investment
duties are broadly analogous to trustees of private pension schemes
and that their obligations are to beneficiaries and scheme employers(see discussion at paragraphs 4.69 – 4.74 of the Law Commission’s
2014 report). Under regulation 7(1) of the LGPS Investment
Regulations, an LGPS authority must formulate its ISS statementsin accordance with governmental guidance. The current guidance
relating to the ISS states that investment decisions should be in the“best long term interests of scheme beneficiaries and taxpayers”,
although the recent case of R (on the application of Palestine
Solidarity Campaign Ltd) v Secretary of State for Housing,Communities and Local Government [2020] UKSC 16 casts somedoubt on the relevance of taxpayer interests.
These areas of governmental intervention may increase in the
future. As noted in paragraphs 23 and 24 of “Part 1 – Introduction
to the PCRIG Guidance” of the PCRIG Guide 2020 “the longer thedelay in climate policy action, the more forceful and urgent any
regulatory policy intervention will inevitably be in order to limit
global average temperature increases to a level that’s more likely
to allow for economic and social stability. This would have a more
severe impact on companies and pension schemes as investors…
companies face increased cost and uncertainty from a disorderly
low-carbon transition and increased physical risks, and investors
face increased risk compared to a scenario where climate policy isenacted smoothly and steadily.”“By 2030, significantly reduce illicit financial and arms flows,
strengthen the recovery and return of stolen assets and combat
all forms of organized crime.” See also commentary from the
UN Office on Drugs and Crime and the UN Commission on
Crime Prevention and Criminal Justice (https://www.unodc.org/
unodc/en/sustainable-development-goals/sdg16_-peace-andjustice.html and https://sustainabledevelopment.un.org/index.
php?page=view&type=30022&nr=656&menu=3170 respectively, bothaccessed at 23 January 2021).
There are provisions in the Environment Bill currently before
Parliament intended to prevent illegal deforestation in the UK’s
international supply chain by requiring implementation of, andreporting on, a due diligence system. The Global Resource Initiative,
a UK government-convened taskforce of leaders from businessand environmental organisations established to consider how theUK can reduce the climate and environmental impacts of key UK
supply claims, Final Recommendations Report, March 2020 page
25 recommended a similar mandatory due diligence obligation for
financial services firms to prevent lending and investment fundingof deforestation, but this is not included in the proposed legislation.
See also Jonathan Ford, “Britain’s necessary but insufficient battle
on modern slavery,” Financial Times, 17 January 2021 . “Failure toprevent”-type offences – see for example, section 10 Bribery Act 2010 –are one way the Government has chosen to do this in other contexts.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Cluster Munitions (Prohibitions) Act 2010, which gives effect to theFreshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

UNITED KINGDOMCONTENTSFOREWORDSINTRODUCTION
Convention on Cluster Munitions. A ministerial statement suggeststhat these provisions are intended to criminalise the provision offunds “directly contributing to the manufacture” of the prohibited
weapons, but that “so-called indirect financing” (including providing
funds generally to companies that manufacture a range of goods,
including cluster munitions) is not prohibited - Written Ministerial
Statements, Foreign and Commonwealth Office, Chris Bryant, Cluster
Munitions Production (Financing) (7 Dec 2009: Column 1WS).
100

The Pension Schemes Act 2021, in force as of February 2021, also
makes provision for “collective money purchase” pension schemesthat are expected to provide a form of target defined benefit thatis not fully guaranteed and can vary depending on funding levels(sometimes referred to as a defined ambition scheme).

101

Required by section 35 of the Pensions Act 1995, with requirements
relating to the content of the SIP provided by regulation 2 of thePrivate Scheme Investment Regulations.

102

TPR, “DC trust: presentation of scheme return data 2018 – 2019”((https://www.thepensionsregulator.gov.uk/en/document-library/research-and-analysis/dc-trust-scheme-return-data-2019-2020
accessed at 14 July 2021).

103

TPR, “DC trust: presentation of scheme return data 2019 – 2020”((https://www.thepensionsregulator.gov.uk/en/document-library/research-and-analysis/dc-trust-scheme-return-data-2019-2020
accessed at 14 July 2021).

service.gov.uk/government/uploads/system/uploads/attachment_
data/file/992082/draft-misc-provisions-regs.pdf (both accessed at
14 July 2021 )respectively and are expected to come into force on 1
October 2021. The final form of the statutory “Guidance for trusteesof occupational schemes on governance and reporting of climatechange risk” can be found at https://assets.publishing.service.gov.uk/
government/uploads/system/uploads/attachment_data/file/995679/
statutory-guidance-final.pdf. (accessed at 14 July 2021). The PCRIG
Guide 2020 provides additional non-statutory guidance. TPR is also
expected to publish guidance on the new regulations following
consultation. The draft guidance also notes that additional, separate
guidance on how climate change risks should be part of a scheme’s
assessment of “employer covenant” (i.e. the legal extent and financial
strength of the support that the employer and its corporate groupprovides to the scheme, considering the latter in its position as
creditor) will be published in future. Broadly, trust schemes with £1billion or more in net assets and authorised master trusts will be
subject to these new governance requirements and, in consequence,
to TCFD reporting requirements (the timing proposals on this, andon reporting on these new governance requirements are covered at
2.2.12 below).
113

Implementing provisions of article 19 IORP II we would suggest that
this should be interpreted consistently with the judge-made law
requirements described in 1.19 and 1.27 above.

114

Or explain why matters have been omitted.

115

See 2.2.15 to 2.2.18 below for an explanation of these terms.

116

Regulation 2(3)(d) Private Scheme Regulations, implementing
Article 3h of SRDII.

117

Recommendation 14 of Investing with Purpose highlights acommitment by the Investment Association and the PLSA
commitment to establish a new steering group to explore how
to embed a focus on long-term factors in the trustee/Investment
Manager relationship. Further details are given at 6.5 below.

See especially sections 33 and 36.

118

Section 33 Pensions Act 1995.

108

See especially section 249A.

119

109

See especially regulations 2 and 4.

110

Some of these requirements do not apply to schemes with under
100 members.

111

TPR is due formally to consult in 2021 on a code of practice
combining the content of its 15 current codes of practice to forma single, shorter code - https://www.thepensionsregulator.gov.uk/
en/document-library/statements/single-code-of-practice-statement(accessed at 14 July 2021). TPR is focussing on the effective systemof governance and the code must cover (among other things)(a) how a fund provides for sound and prudent management ofactivities, (b) how it includes consideration of environmental, socialand governance factors related to investment assets in investment
decisions and (c) an own risk assessment covering (among otherthings) where environmental, social and governance factors are
considered in investment decisions, how the trustees assess newor emerging risks, including (i) risks relating to climate change,
the use of resources and the environment; (ii) social risks; and (iii)risks relating to the depreciation of assets as a result of regulatorychange. The new code and the changes to the guidance relating togovernance are intended to implement various IORP II requirements.

TPR Investment Guidance for DB schemes and TPR Investment
Governance for DC schemes. See also PLSA, Stewardship and Voting
Guide 2020: “There is a growing body of evidence to demonstratethat active and engaged shareholders can have a positive impact
on corporate performance. That is why the PLSA has long been
active in helping its members engage with investee companies…
to protect and enhance the value of savers’ capital…Although theterm ‘stewardship’ is often used interchangeably with ‘ESG’, theissues upon which schemes should act as good stewards encompass
anything potentially financially material: from strategy, performanceand treatment of ‘traditional’ financial risks to topics such as climatechange, human rights or board and workforce diversity.”

104

Unfunded public schemes are not covered in this annex because
this analysis in not relevant to them; pensions are not paid out ofinvestment proceeds.

105

The LGPS has over 5.9 million members and its funds have an
estimated aggregate market value of £287.2 billion in assets. Ministryof Housing, Communities and Local Government, “Local Government
Pension Scheme Funds: England and Wales 2018-19,” pages 1 and 5..

106Which have been amended to implement IORP II requirements.

107

112

502

These sections were inserted on 31 May 2021 by section 124 Pension
Schemes Act 2021 (Commencement No 1) Regulations 2021 (SI2021/630)). The DWP Climate Risk 2021 Consultation and June 2021
Government response to this consultation explain the approach.
The Occupational Pension Schemes (Climate Change Governanceand Reporting) Regulations 2021 can be found at The Occupational
Pension Schemes (Climate Change Governance and Reporting)
Regulations 2021 (legislation.go.uk) and https://assets.publishing.

120

Recommendation 16, which is expected to be established byJune 2021.

121

The regulation is due to come into force on 1 October 2021: (seeendnote 111).

122

In response to concerns that have been raised in consultation about
the difficulties pension scheme trustees may face in obtaining
sufficient data to comply with their reporting obligations, the DWP
has proposed that trustees are only expected to comply “as far as
they are able”. The draft regulations clarify that this requires trustees
to take “all such steps as are reasonable and proportionate in theparticular circumstances”, taking into account the time and costs
that will be (or are likely to be) incurred by the scheme in meeting
its reporting obligations.

123

Academic consensus on this has recently been confirmed in R (onthe application of Palestine Solidarity Campaign Ltd) v Secretaryof State for Housing, Communities and Local Government [2020]
UKSC 16, paragraphs 12, 30 and 42 approving statements to thiseffect in the 2014 Report.
124

Regulation 58 of the Local Government Pension Scheme
Regulations 2013 (SI 2013/2356).

125

Department for Communities and Local Government, “Local
Government Pension Scheme Guidance on Preparing and
Maintaining an Investment Strategy Statement,” July 2017 and page
10 of Investing with Purpose.

126

https://assets.publishing.service.gov.uk/government/uploads/system/
uploads/attachment_data/file/933783/FINAL_TCFD_ROADMAP.pdf(accessed at 14 July 2021), at paragraph 1.17. At a PLSA conferencein May, senior policy adviser, Oliver Watson, indicated that the
department was close to issuing its consultation and that thedirection the consultation would take would be “very similar” to the
DWP proposals described in this section.

127

https://www.thepensionsregulator.gov.uk/en/document-library/statements/climate-change-joint-statement (accessed at 14 July2021). For DB schemes, the relevance of the employer covenant
presents an additional complication. As TPR notes many schemes
are also supported by employers whose financial positions andprospects for growth are dependent on current and future policies
and developments in relation to climate change.

128

Private Scheme Investment Regulations, reg 2(4). This definition
is not on all fours with the test described in 1.36 above which
envisages the possibility of a financially material consideration which
the trustees fail to identify in breach of the duty of care.

129

130

131

Private Scheme Investment Regulations, reg 2(4). The statutory
guidance for trustees of occupational schemes on governance andreporting of climate change risk says, in Part 3 (“Climate change
governance and production of a TCFD Report”) paragraph 44 (whendiscussing the time horizons to be used in TCFD disclosures) “It is
up to trustees how they determine their time horizons. However, indeciding what the relevant time horizons are, trustees must take into
account the scheme’s liabilities and its obligations to pay benefits.
Trustees should also take account of the following…In a DB scheme…
the likely time horizon over which current members’ benefits will
be paid. This may be the longest time horizon they will need toconsider…In a DC scheme…the likely time horizon over which current
members’ monies will be invested to and through retirement. Thismay be the longest time horizon they will need to consider.”TPR, “Investment governance: Investment decisions and yourstatement of investment principles,” July 2016 https://www.
thepensionsregulator.gov.uk/en/trustees/managing-dc-benefits/investment-guide-for-dc-pension-schemes- and TPR, “Regulatory
Guidance: DB investment, Investing to fund DB,” March 2017 https://www.thepensionsregulator.gov.uk/en/document-library/regulatoryguidance/db-investment/investing-to-fund-db (both accessed at 14
July 2021). .
The PLSA publication “More Light, Less Heat: A Framework for
Pension Fund Action on Climate Change” provides some usefulexamples of how particular funds have chosen to approach climatechange risk.

132

See the July 2017 guidance issued by the then Department ofCommunities and Local Government on preparing and maintaining
an Investment Strategy Statement.

133

The time horizon will be shorter for trustees of schemes approachingbuy-out or wind-up.

134

Manager of the University Superannuation Scheme, one of the UK’s
largest private pension schemes with the California State Teachers’
Retirement System (US) and the Government Pension Investment
Fund of Japan.

135

Cowan v Scargill [1985] 1 Ch 270 which should be understood as a
general requirement of fairness (see 1.42 above).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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UNITED KINGDOMCONTENTSFOREWORDSINTRODUCTION136

See “Tackling poor standards of governance and risk managementin pensions are priorities for TPR” https://www.thepensionsregulator.
gov.uk/en/document-library/statements/climate-change-jointstatement (accessed at 14 July 2021).

137

Advice is potentially required under the Pensions Act 1995. Section
36 Pensions Act 2005.

138

2020’s global pandemic, for example. Investing with Purpose
includes a section on investors’ role in the Covid-19 crisis and postCovid recovery. On 1 December 2020, the UN-convened Sustainable
Insurance Forum announced that Insurance supervisors from theforum are to undertake a landmark scoping study on the financial
risks of biodiversity loss and analyse how insurance supervisors andinsurance companies are responding to these risks.

139

See, paragraph 6.30 of the 2014 Report and paragraphs 24 and 34
of the 25 November 2016 abridged joint opinion for ClientEarthof Keith Bryant QC and James Rickards https://www.documents.
clientearth.org/wp-content/uploads/library/2016-12-02-the-legalduties-of-pension-fund-trustees-qc-opinion-ext-en.pdf (accessed at
14 July 2021).

140

TPR guide to Investment Governance for DC schemes page 12 “Itis important to understand the implications of the systemic riskof climate change on investment decisions in the context of yourscheme when developing your SIP”. The PCRIG Guide 2020 contains
the important warning for DC schemes in part I paragraph 31 that“trustees must not relegate the consideration of climate change
to members via [chosen] funds. Rather, trustees must consider its
relevance as part of their duty to provide both a default fund and[chosen] funds appropriate to the needs of the membership.”

141

142

Although it is clear that the Investment Managers appointed by aPension Fund have a critical role to play. As the March 2020 Open
Letter says “asset managers that integrate ESG factors throughout
their entire investment process, vote according to the mandate towhich they have pledged, and are transparent with us about theirlevel of corporate engagement, demonstrate to us that they arecommitted to long-term value creation in line with our interests…
asset managers who commit to sustainable value creation are notinjecting politics into business, nor are they “virtue signalling.” They
are fulfilling their duty to us, and by extension, to the millions offamilies depending on us.”Investing with Purpose notes on page 46 “The incomparability andinconsistency of ESG information and the proliferation of standards
and frameworks to solve…this has resulted in a wide range of market
inefficiencies, including increased costs from duplicated reporting,verifying ESG data across the investment chain and ultimately thepotential mispricing of assets.” Paragraph 27 PCRIG Guide 2020 says“the market pricing of assets will say little about a given investor’s
own attitude or tolerance to risk, or the implications of different
climate scenarios. Trustees should therefore be wary about relying onmarked to market pricing of assets as a measure of climate-related
financial risks.” .

143

Paragraphs 15 and 19.

144

As Keith Bryant QC and James Rickards note at paragraph 50 of
their 25 November 2016 abridged joint opinion for ClientEarth “It isdifficult (and undesirable) in our opinion to attempt to formulate any
rigid approach to determining whether a particular factor, such as
climate change, will or will not give rise to a financially material risk;
what is and what is not financially material is likely to be highly fact
sensitive.” Friends of the Earth’s UN Divest campaign calls on public
and private institutions to divest from fossil fuels. It is foreseeable
that other parties may frame claims on the basis that an Asset
Owner has not fully utilised the available flexibility within the current
legal regime to the extent it could have achieved a greater positive,
or reduced or prevented a negative, sustainability impact.

145

503

Where the strategy is a passive one, it may be possible to substitutethe index being tracked with one which excludes the investments
the trustees would otherwise choose not to invest in.
146

Paragraph 4 Part II of the PCRIG Guide 2020 also says “trustees
should consider the internal consistency of their investment beliefs.
For example, trustees of defined contribution schemes who believein the efficacy for the scheme’s default fund of a pure passive
market-cap weighted fund with no flexibility to reduce allocations
selectively should consider how this will reconcile with strong beliefs
in relation to the impact of climate change on markets during thetime horizon of the scheme’s members. Likewise, trustees whobelieve in the ability of asset managers to identify and exploit asset
mispricing should consider how this reconciles with a view thatclimate-related risks alone have been adequately ‘priced in’ tocompany valuations.”

147

Appendix 1 to the PCRIG Guide 2020 contains a list of climatechange-focussed due diligence questions to consider asking an
investment manager.

148

https://equitygenerationlawyers.com/cases/mcveigh-v-rest/ (accessed
at 14 July 2021).

149

In June 2020, ClientEarth launched a campaign to encourage
individuals to connect with their pension providers and “challenge
them over their legal duties on climate change”. The Make My Money
Matter campaign is wider-ranging: “As soon as people discover theirmoney is invested, most want it to do good while it’s growing. In fact,
68% of UK savers want their investments to consider people andplanet alongside profit. So we’re going to help people find out where
their money’s going and demand it does better. That can be throughinvestments in more positive industries, or by using our pension
power to ensure companies transition to more sustainable practice.”https://makemymoneymatter.co.uk (accessed at 14 July 2021).

150

151

152

Although see, for example, https://www.lgim.com/landg-assets/lgim/_
document-library/capabilities/lgimh-controversial-weapons-policy.
pdf (accessed at 14 July 2021) “Controversial weapons are those thathave an indiscriminate and disproportional humanitarian impact
on civilian populations; the effects of which can be felt long after
military conflicts have ended…we do not deem these companies
to be a good investment based on their reputational risk profile…
the market for such weapons is very limited and involvement brings
reputational risk. We believe it makes business and investment sense
for companies to reconsider their involvement.” Paragraphs 6.64
and 6.65 of the 2014 Report appear to assume that a decision to
avoid investment in controversial weapons is necessarily based on a
non-financial factor. This example suggests that the decision could
instead be a financial one.
See the passage from Investing with Purpose at 3.2.4 below. The
Financial Times (31 January 2021) reported that Aviva Investors has
called on thirty of the world’s largest oil, gas, mining and utilities
companies to set net zero emission goals and integrate climate risks
into their strategy (including their plans for capital expenditure) andhas said that it will divest both equity and fixed income holdings ofany company which fails to meet these expectations over the next
one to three years. The PCRIG Guide 2020 says (at paragraph 3 ofpart II) that trustees may wish to consider, in the context of theirinvestment beliefs, the balance between engagement, voting and/or
divestment as appropriate tools to manage climate-related risks.
At a recent sustainable investment festival, the Pensions Minister,
Guy Opperman is reported in Professional Pensions as saying: “Icannot state how much I oppose this [divestment]…It is a fool’s
errand to describe yourself as sustainably investing when you divest
from all inappropriate stocks and simply invest in tech, for instance.”https://www.professionalpensions.com/news/4033298/divestmentsin-stocks-fool-errand-opperman (accessed at 14 July 2021).

153

Law Com No 374.

154

See further discussion in Report on Pension Funds and Social

Investment, 2017, Law Com No 374 2017 at paragraph 5.50. The Law
Commission’s views are not binding but are likely to be regarded
as at least persuasive by English courts. We have not identified any
examples in case law of such a duty arising in practice.
155

The PCRIG Guide 2020 notes at paragraph 3 of part I that “Sectionsof the guidance may be of interest to others, including managers offunded public sector schemes.” The Environment Agency Pension
Fund’s “Getting to Net Zero and Building Resilience” Policy toAddress Climate Change (March 2021) is an example of IFSI – https://www.eapf.org.uk/~/media/document-libraries/eapf2/policies/2021/
eapf-policy-to-address-climate-change-publication-version.pdf?la=en&hash=4D4E12DC50B01D6E0C85706A41AEDD9A33A4D679 or
https://www.eapf.org.uk/investment/policies (both accessed at 14
July 2021).

156

Private Scheme Investment Regulations, reg 2(4). Contrast thedefinition of “financially material considerations” as including (butnot limited to) “environmental, social and governance considerations(including but not limited to climate change), which the trustees of
the trust scheme consider financially material”.

157

Private Scheme Investment Regulations, reg 2(4). Contrast thedefinition of “financially material considerations” as including (butnot limited to) “environmental, social and governance considerations(including but not limited to climate change), which the trustees of
the trust scheme consider financially material”.

158

TPR, “Investment governance,” https://www.thepensionsregulator.
gov.uk/en/trustees/managing-dc-benefits/investment-guide-fordc-pension-schemes- (accessed at 14 July 2021). See also TPR’s
guidance on Investment Governance for DB schemes: https://www.thepensionsregulator.gov.uk/en/document-library/regulatoryguidance/db-investment/db-investment-governance (accessed at 14
July 2021).

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

159

In reaching their conclusion, the Law Commission considered anumber of cases, including Cowan v Scargill [1985] Ch 270 (see above),
Martin v City of Edinburgh District Council [1989] Pens LR 9, 1988 SLT
329 and Harries v Church Commissioners [1992] 1 WLR 1241.

Brazil160

R (Palestine Solidarity Campaign Ltd) v Secretary of State[2020] UKSC 16 at [43], Lord Carnwath JSC stated that the Law
Commission’s report “may be seen as having settled a long-runningdebate as to the extent to which pension trustees could takeaccount of non-financial factors…There appears now to be general
acceptance that the criteria proposed by the Law Commission arelawful and appropriate. I agree.”

China

161

TPR, “Investment governance,” July 2019 https://www.
thepensionsregulator.gov.uk/en/trustees/managing-dc-benefits/investment-guide-for-dc-pension-schemes (accessed at 14 July 2021)..

162

At least in part because the underpinning case-law is rooted incharitable trust cases that arguably cannot and/or should not bereadily applied outside this context. See the discussion of Harries v
Church Commissioners in Bennet, “Must an occupational pension
scheme take into account ESG factors even if there is a risk offinancial detriment to the pension fund?” Trust Law International;
Vol 32 (2019). Lord Carnwath’s comments referred to in endnote 159
are obiter.

163

See the discussion of Cowan in “Pension Scheme Investment: Is it
always just about the Money? To what extent can or should trustees
take account of ethical or ESG factors when Investing?” Daykin, Trust
Law International; Vol 28, No 4 (2014).

164

At one extreme, it has been argued that consideration of “nonfinancial” factors is only permissible in a “tie-break” scenario, asa way of choosing between two choices which are equal from afinancial return perspective. The 2014 Report considers that this is
too narrow an interpretation, stating that trustees have discretionin the way that they assess financial detriment provided that they
apply their minds to the question and take professional advice about

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it (para 6.76). As a possible further disincentive, section 107 Pension
Schemes Act 2021 inserts a new section 58B into the Pensions
Act 2004 containing a criminal offence of knowingly or recklessly,
and without reasonable excuse, acting or engaging in a course of
conduct that detrimentally affects in a material way the likelihoodof accrued scheme benefits being received. This may deter sometrustees from taking into account in their investment decisionmaking something which is not legally required although therequired mental threshold is high, and if the Non-Financial Factors
Test is met, the decision should not involve a risk of significant
financial detriment to the fund.
165

166

LGPS Pension Scheme Advisory Board, England and Wales, Board
Guidance on the role of non-financial considerations in LGPS investment,
May 2018 and Department for Communities and Local Government,
Local Government Pension Scheme Guidance on Preparing and
Maintaining an Investment Strategy Statement, July 2017.
FCA, Authorised and recognised funds, https://www.fca.org.uk/firms/
authorised-recognised-funds (accessed at 7 July 2021). We have notcovered AIFs - the EU’s other main form of collective investment
vehicle - as these are much less commonly sold to retail investors.
They are also much less tightly regulated in terms of permitted
investments etc. and regulation is mainly directed at the manager,rather than the fund itself. Pooled pension vehicles are generally AIFs.

167

OEICs are established and authorised by the FCA under the OpenEnded Investment Companies Regulations 2001 (SI 2001/1228).

168

Authorised unit trusts are established under trust law (FSMA s.
237(3)) and authorised by the FCA under section 243 FSMA.

169

Exchange traded funds (ETFs) are the most popular typeof exchange-traded product in the UK. ETFs that follow theperformance of an index or market are commonly known as passive,or tracker, funds. https://www.fca.org.uk/consumers/exchangetraded-products (accessed at 14 July 2021).

170

In CP20/5 “open-ended investment companies: proposals for a more
proportionate listing regime” at paragraphs 2.2 and 2.3, the FCA
notes that, in response to an earlier discussion paper “stakeholders
noted that underlying funds regulation that applies to authorised
funds and their managers (for example rules which implement the
UCITS Directive), offer significant protections for investors, including
retail investors. The feedback suggested that the main source ofinvestor confidence in ETFs comes from the rules for funds rather
than the Listing Rules. In addition, stakeholders noted that investors
relied on funds documentation such as a UCITS prospectus, rather
than the listing particulars currently required under the Listing Rules.
Therefore, stakeholders stated that the current Listing Rules impose
an unnecessary, additional layer of regulation that does not serve any
valuable purpose for investors.”

171

COLL 6.2.16R. Article 1(2) UCITS Directive.

172

Article 19(6) UCITS Directive. The AFM will commonly delegate
investment to an Investment Manager but will retain responsibility
for the Investment Manager’s decisions: COLL 6.6.15R(1) - (1A) and6.6.15AR(3).

173

The KIID must include appropriate information about theessential characteristics of the fund so that prospective investors
are reasonably able to understand the nature and risks of theinvestment product that is being offered to them and, therefore, totake investment decisions on an informed basis (COLL 4.7.2R(3) andarticle 78(2) UCITS Directive).

174

COLL 4.2.5R. The KIID may potentially provide additional, relevant
information. article 78 UCITS Directive.

175

COLL 4.2.5R(3) (article 78 (3(b)) UCITS Directive) requires theprospectus to set out the investment objectives, including thefund’s financial objectives; the investment policy for achieving thoseinvestment objectives, including the general nature of the portfolio

504

and, if appropriate, any intended specialisation; and an indicationof any limitations on that investment policy. COLL 4.2.6G (article
69 (2) UCITS Directive), which provides guidance on the contentsof the prospectus says, by way of guidance on what should besaid about the investment policy, a prospectus might include a
description of any restrictions in the assets in which investment
may be made, including restrictions in the extent to which thefund may invest in any category of asset, indicating (if appropriate)
where the restrictions are more onerous than those imposed by
COLL 5 (Annex 1 Schedule A (1.15) UCITS Directive). In the case of anumbrella fund, the investment objective of each sub-fund must be
set out in the instrument of incorporation as well (see paragraph 4,
Schedule 2 Open-Ended Investment Companies Regulations 2001
(SI 2001/1228). See 5.3.3 below for how the investment objective andthe investment policy can be amended during the life of the fund.
176

COLL 4.2.5R(3)(ca)(ii).

177

COBS is modified in its application to an AFM by COBS 18.5B and in
relation to an OEIC without a separate management company by
COBS 18.9.

178

COLL 5 (limits are summarised in COLL 5.1.2G and 5.1.4G) and, inparticular 5.2.3R and 5.2.7AR(1)(b).

179

COLL 6.6.3R(3)(a). COLL 6.6.14R(1) says “The [AFM] must avoid thescheme property being used or invested contrary to COLL 5, or any
provision in the instrument constituting the fund or the prospectus
as referred to in COLL 5.2.4 R (Investment powers: general), COLL
5.6.4 R (Investment powers: general).”180

COLL 6.6A.2R reflecting article 14 UCITS Directive.

181

COLL 6.6A.5R reflecting article 14(1)(e) UCITS Directive.

182

COLL 6.6.5R(1) states that “the duties and powers of the [AFM] under
COLL and under the instrument constituting the fund are in addition
to the powers and duties under the general law.”

183

COLL 4.2.2R and 4.2.4R - the liability to pay compensation under thelatter rule is in addition to any other liability it may have, for example
under section 90 FSMA. As regards the KIID, see COLL 4.7.2R and section
90ZA FSMA sets out potential liability for the KIID where it is misleading,inaccurate or inconsistent with relevant parts of the prospectus.

184

The relationship between the OEIC and its unitholders might well
not be regarded as fiduciary, but the regulatory duty of loyalty has
broadly similar content (see 1.21 above) to what we have calledfiduciary duty in the Annex (see 1.19 above).

185

In the case of an OEIC, the AFM is its authorised corporate director.
Some assistance as to the nature of the relationship between the
OEICs directors and the OEIC itself is given in regulation 35 OEIC
Regulations which provides “(1) The matters to which a directorof an open-ended investment company must have regard in theperformance of his functions include the interests of the company’s
employees in general, as well as the interests of its shareholders (2)The duty imposed by this regulation on a director is owed by him to
the company (and the company alone) and is enforceable in the same
way as any other fiduciary duty owed to a company by its directors.”186

to the UCITS scheme itself, such as COLL 6.6A.2R (reflecting article
14 UCITS Directive) and 6.6A.5R (reflecting article 14(1)(e) UCITS
Directive). As regards OEICs, Palmer’s Company Law (release 170,
second release for 2021, April 2021), says in chapter 5A.102: “Thefinancial institutions…bear fiduciary duties to the investors” and5A.232 “it is suggested that the management company, or ACD,
occupies a fiduciary relationship in respect of the OEIC.”As regards a tortious duty of care, given the valuation transparencyof a UCITS scheme, we think the precedent of Robinson v Chief
Constable of West Yorkshire Police [2018] UKSC 4 is not necessarilya reliable one.
187

Unlike the DWP proposals, the FCA proposals do not include
provisions on governance and risk management because the
FCA considers broadly that these already apply under its existing
requirements (paragraph 2.20 of CP21/17). It is also providing
limited flexibility for firms to provide some disclosures on a “bestefforts basis, for example where methodologies for certain metrics
are not yet widely established” and to allow use of proxy data orassumptions where relevant information is not available from
portfolio companies (paragraphs 3.34 and 3.36). Entity level reports
may also recognise group membership (paragraphs 4.16 to 4.20)..

188

This is defined in the FCA Handbook glossary as “a documented
system of internal limits concerning the measures used by the
AFM to manage and control the relevant risks for the scheme,
taking into account all the risks which may be material to the
UCITS including, but not limited to, liquidity risk, counterparty risk,
market risk and operational risk and ensuring consistency with the
UCITS “risk profile”. It cross-refers to articles 38(1) and 40(2)(d) UCITS
Implementing Directive (the former is discussed in 2.3.10).

189

190

191

It is less clear whether a court would also conclude that it owes
any of these judge-made law duties described in (b)(i) directly tounitholders when exercising its investment decision-making powers.
As regard fiduciary duties, in its 2014 Report the Law Commission
concluded that, in rare cases, an Investment Manager may owe
fiduciary duties to the Beneficiaries of an Asset Owner. We consider
a court would take a similar approach here, although T C Cornick,in Collect Investment Schemes: the Law and Practice (1989),
expressed the views, as regards unit trusts, that “the manager of thescheme stands in a fiduciary relationship with the holders” (A1.043)
and “it seems generally accepted that the manager is subject to thesame fiduciary duties as the trustee” (A4.179). This may be basedon rules applying to the AFM, which refers to unitholders as well as

As part of the EU Sustainable Finance Package the Commission is
proposing to amend article 23 of the UCITS Implementing Directive
to require AFMs to take into account sustainability risks, meaning“an environmental, social or governance event or condition that,
if it occurs, could cause an actual or potential material negative
impact on the value of the investment” when complying with theserequirements (European Commission legislative proposal of April
2021, amending Directive 2010/43/EU as regards the sustainability
risks and sustainability factors to be taken into account for
Undertakings for Collective Investment in Transferable Securities).
The Commission is also proposing in the legislative proposal referred
to in the previous endnote to insert a reference to sustainability risks
into this article. In the explanatory memorandum to the proposed
legislation, the Commission states that this change “clarifies thatthe risk management policy under Article 38 of Directive 2010/43/
EU must also consider exposures of UCITS to sustainability risks.” This
supports our view that the insertion of “sustainability” into article 38(1)of the UCITS Implementing Directive is a clarificatory amendment
since the risk limit system is already required to deal with “all…risks…
which may be material for each UCITS [the AFM] manages”.
The relevant FCA Handbook Glossary definition is “the risk of loss fora UCITS…resulting from fluctuation in the market value of positionsin the fund’s portfolio attributable to changes in market variables,such as interest rates, foreign exchange rates, equity and commodity
prices or an issuer’s credit worthiness”. Paragraph 4.10 of the FCA’s
DP18/8 “Climate Change and Green Finance” acknowledges that, forexample, climate change transition risk gives risk to market risk.

192

Page 33 of the Risk Management chapter.

193

For example, there are plans to close it.

194

It appears to be common for UK UCITS to give a period of this kind,
whether or not they are strictly required to by COLL 4.2.5R(3)(ca)(ii),which requires this to be stated for any fund that “has indicated in
its name, investment objectives or fund literature (including in any
financial promotions for the fund), through use of descriptions suchas ‘absolute return’, ‘total return’ or similar, an intention to deliver

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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positive returns in all market conditions”. Some refer to returns “overthe long-term”.
195

The Blackrock and Vanguard Stewardship Code statements referred
to in 6.8 below show how the particular characteristics of a scheme
are important to this determination - “our [index fund] clients are,by definition, long-term and locked-in shareholders” and “[our] index
funds…are practically permanent—structurally long-term—owners of
the companies in which they invest.”

196

COLL 3.2.6R(7), partly based on article 1(2) UCITS Directive.

197

FCA, Policy Statement PS19/4, “Asset Management Market Study- further remedies,” 2019 Appendix 2, non-handbook guidance atparagraph 19. This is presumably intended to pick up the COLL
4.2.5R(3)(c) (reflecting Annex 1, Schedule A (1.15) UCITS Directive)
requirement that the prospectus must set out an indication of any
limitations on the investment policy.

198

199

This is somewhat borne out by a Morningstar Report “European
Sustainable Fund Flows: Q2 2020 in Review” which says (emphasis
added) “One would be forgiven for assuming that repurposed funds
are simply greenwashed and/or there hasn’t been a complete
revamp of the holdings or strategy. It is true that some funds do notmake many changes. This could be because ESG factors are alreadyextensively incorporated into the investment process and only a few
exclusions are added to the strategy.”
FCA Policy Statement PS19/4, Asset Management Market Study further remedies, 2019 at paragraphs 6, 11, 18, 19, 21, 29 and 30,
Appendix 2. See also: PRIIPS Regulation (1286/2014), article 8(3)(c) (applicable to the UCITS KIIDs from 2022, under article 32, as
amended); Joint Committee of the European Supervisory Authorities,
Joint Technical Advice on the procedures used to establish whether
a PRIIP targets specific environmental or social objectives, at page
11 (available here); the template Key Investor Information Document
published by the Committee of European Securities Regulators(available here); and industry body guidance from the UK Investment
Association (“Fund communication Guidance,” February 2019) (allaccessed at 14 July 2021).

200

Which make up around 3% of UK insurers’ economic activity; ONS,
Experimental financial statistics for insurance using Solvency II
regulatory data - enhanced financial accounts (UK flow of funds), 2018.

201

Which make up approximately 6% of the UK life insurance market;
Alternative Investment Report, “Business Property Relief Industry
Report 2015,” 2015.

and Markets Act 2000 (Regulated Activities) Order 2001/544) but
excluding group self-invested personal pensions for the purposes of
the Annex.

ACKNOWLEDGEMENTS

209

The FCA’s ‘Unit-linked funds’ governance review (follow up to
PS18/8): findings and next steps” notes that savers in “most defined
contribution pension schemes” are investors in unit-linked funds.

221

For example, PRA Rulebook, Solvency II, Investments, Rule 5(2)-(3)).
Unit-linked life insurance policies are subject to additional, moreprescriptive requirements under COBS 21 regarding permitted assets.

EXECUTIVE SUMMARY

210

74% of policyholders included in the schemes covered by this survey
are in the default fund (see The DC Future Book: in association
with Columbia Threadneedle Investments (2020 Edition), page 18).
https://www.pensionspolicyinstitute.org.uk/media/3615/20200923the-dc-future-book-in-association-with-cti-2020-edition.pdf.
(accessed at 14 July 2021).

222

The current amount the insurer would have to pay for an immediatetransfer of its liabilities to a third party (PRA Rulebook; Solvency IIfirms; Technical Provisions 2.2).

A. INVESTING FORSUSTAINABILITY IMPACT

211

212

223

PRA Solvency II Rulebook, Investment Rule 3.

224

There is some overlap; for example, the drafting of some of the
Principles for Business and Fundamental Rules is identical, but the
PRA and FCA approach them from different perspectives.

COBS 20.2.1AR There are specific “with profits” governancearrangements referred to in COBS 20.5.

225

COBS 21.1.1AR.

Policyholder funds is a convenient term to describe the insurer’s
assets which back life policies. The assets nevertheless belong to theinsurer; the policyholders do not have any proprietary rights in them.
Foskett v McKeown [2001] 1 AC 102 at page 120.

226

Individually and collectively and to manage conflicts, where theyarise, effectively (COBS 19.5.6G).

227

COBS 19.5.2R and COBS 19.5.5R(2B)(b)-(d), including consideringand reporting on the extent to which the firm has implemented
its stated policies (COBS 19.5.5R(2E)). Where the insurer has nosuch policy, the IGC or GAA will consider and report on the insurer’s
reasons for not having a policy (COBS 19.5.5R(2C).

213[2019] EWCA Civ 718. See also UK Acorn Finance Limited v Markel(UK) Limited [2020] EWHC 922 (Comm).

214

PRA fundamental rule 2 imposes an identical due care, skill anddiligence requirement to PRIN 2.1.1R(2). As regards conflicts, in
TR13/8 the FCA looked at the governance of unit-linked funds andgave the following examples of conflicts (a) the “seeding” of new fundswith shareholder funds or other policyholder funds which can leadto conflicts when seeding capital is withdrawn, as this could affectthe fund value, (b) the need, or desire, to use existing policyholder
funds to seed new funds could encourage firms to invest in amanner incompatible with investment mandates, fund objectives
or customers’ best interests and (c) an insurer making use of thewith-profits fund or inherited estate to support its unit-linked business– for example, to provide liquidity or subsidise costs. If this conflict ofinterest is not managed it could disadvantage with-profits customers.

215

PRIN 2.1.1R(4) and Fundamental Rule 4 also address this.

216

PRA Rulebook, Solvency II, Solvency Capital Requirement chapter,
Technical Provisions chapter and related chapters and guidance.

217

PRA Rulebook, Solvency II, Conditions Governing Business andrelated chapters and guidance.

218

In SS1/20 Solvency II: the prudent person principle, the PRA notesthat insurers “must ensure that their investments do not expose
them to risks that cannot be managed effectively in accordancewith the requirements of the rules in the Conditions Governing
Business and the Investments Parts of the PRA Rulebook. The
more complex the risk and the less understood it is (e.g. climaterisk), the more difficult it is for firms to manage their exposure tosuch risks effectively. Therefore, the PRA expects firms to be able
to pay particular attention to such risks in their investment risk
management policy and to avoid over-exposure to such risks.”

202

Which make up around 9% of the UK insurance market;
Association of Financial Mutuals, “Mutuals – a history,” https://www.
financialmutuals.org/owned-by-you/mutuals-a-history/ (accessed at
14 July 2021).

203

OECD, Global insurance market trends, 31 January 2020. The
remainder of portfolios are invested in cash and deposits, land or
buildings, collective investment schemes and “other”.

204

Association of British Insurers, “UK Insurance and Long-Term
Savings: The state of the market 2019” page 6 quotes statistics that
UK general insurers managed £143 billion of investments in 2017,
compared to £1.7 trillion for UK life insurers.

219

205

FCA Review of the fair treatment of with-profits customers (TR19/3,
page 3, paragraph 1.5).

Fundamental Rule 3 requires that a firm act in a prudent mannerand see PRA Rulebook, Solvency II, Investments – Prudent Person
Principle: General Principles.

220

206

Unit-linked funds account for approximately £1 trillion of assets (FCA
unit-linked funds’ governance review (follow up to PS18/8) findings
and next steps)).

207

The FCA Review of the fair treatment of with-profits customers(TR19/3) at 1.4 notes that “At the end of 2017, about £274bn wasinvested in with-profits funds, compared with about £1,147bn inunit-linked funds.”

208

Personal Pension Schemes (as defined in Article 3, Financial Services

PRA Rulebook, Solvency II Investments Rule 2.1(3) Investments.
Although not express in the rules, we expect that a conflict for these
purposes could refer to a conflict between policyholders or a conflict
between a policyholders and other parties, such as the insurer. For
example, PRA Consultation Paper CP 22/19, “Solvency II: Prudent
Person Principle, September 2019” at 7.4 notes in relation to intragroup loans that the conflict of interests provision in the prudent
person principle “applies to all asset classes but is highlighted
here as the PRA considers that investment in intra-group assets
is very likely to lead to a conflict of interest (for example: between
shareholders and policyholders; between subsidiaries and parent

505

companies; and between policyholders in different subsidiaries)”. See
also COBS 2.1.1R(1) and the discussion of “best interests” at 1.27 to
1.31 above.

228

These broadly mirror aspects of the judge-made law relating to
the exercise of fiduciary powers set out at 1.25 to 1.42 above. The
directors of an insurer do not generally owe duties directly toshareholders, but instead owe them to the insurance company itself.

229

Companies Act 2006, section 172(1).

230Companies Act 2006, section 171. The latter requirement is not
subsumed into the general purpose test described in (A), but must
be considered separately – see Eclairs Group Ltd v JXK Oil and Gas
plc [2015] UKSC 71 where the directors honestly believed that what
they were doing was in the best interests of the company, but theSupreme Court concluded that their exercise of the power to suspend
voting rights was nevertheless exercised for improper purposes
because it was done with a view to blocking the exercise of therelevant voting rights at a forthcoming shareholders’ meeting, rather
than for the proper purpose of broadly, enabling the directors to
obtain accurate information about ownership of the relevant shares.

231

Companies Act 2006, section 173.

232

Companies Act 2006, section 174. .

233

Re HLC Environmental Projects Ltd (in liq.) (Hellard v Carvalho)[2014] B.C.C. 337. This case may also provide a basis for a court toconclude that the rationality test in the Braganza case (see 2.4.5(b)above) also applies in respect of directors’ duties. In the HLC case thejudge said “I consider that it also follows that where a very materialinterest [in that case the interest of a creditor] is unreasonably(i.e. without objective justification) overlooked and not taken into
account, the objective test must equally be applied. Failing to take
into account a material factor is something which goes to thevalidity of the directors’ decision-making process. This is not the
court substituting its own judgment on the relevant facts (withthe inevitable element of hindsight) for that of the directors madeat the time; rather it is the court making an (objective) judgment
taking into account all the relevant facts known or which ought tohave been known at the time, the directors not having made sucha judgment in the first place.” No court has yet expressly applied
Braganza to directors’ duties.

234

See COBS 9.2.1R; COBS 9A.2R; COBS 9A.2.3AR; and COBS 19.2R.
See also endnote 54, as regards the possible application of PRIN
2.1.1R(9) during the life of unit-linked policies. In the 2014 Report atparagraph 8.53 the Law Commission said “There is also a lack of aclear duty on providers to monitor ongoing suitability over time. For
default funds this is partially addressed by DWP guidance, though
until now this has not had regulatory force.” We cannot see that the

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position has materially changed in the interim and, in any event,the DWP guidance referred to by the Law Commission (“Guidancefor offering a default option for defined contribution automatic
enrolment pension schemes”, May 2011) appears to address
suitability in the sense of product governance and suitability forthe employees / scheme members for whom the fund is intended(see paragraphs 17, 21, 26 and 38), rather than in the sense ofongoing decision-making throughout the course of the relationship.
Outcome 5 of the FCA’s fair treatment of customers “consumers
are provided with products that perform as firms have led themto expect…” is potentially relevant and this area may further be
addressed as part of the FCA’s proposals arising from its proposed
new consumer duty (see (CP21/13).
235

See 1.60 above..

236

Under the PRA Solvency II Rulebook, Reporting Parts 2 to 6. SS3/19
notes in paragraph 3.19 in relation to Pillar 3 that insurers “should
consider whether further disclosures are necessary to enhancetransparency on their approach to managing the financial risks fromclimate change, in line with the expectations set out in this SS. In
particular,…firms…should consider disclosing how climate-related
financial risks are integrated into governance and risk management
processes, including the process by which a firm has assessed
whether these risks are considered material.” Page 6 of the Treasury’s“a Roadmap towards mandatory climate change” says “no additional
regulatory requirements are proposed at this time for [generalinsurers]; the PRA continues, through its supervisory expectations
and engagement, to embed climate-related reporting for [relevant
firms] by end-2021. The PRA will review disclosures after thisdeadline and determine whether additional measures are required.”See 2.4.9 below as regards life insurers.

237

SYSC 3.4.8R implementing article 3h(1) SRD.

238

SYSC 3.4.9R implementing article 3h(2) SRD.

239

COBS 21.2.4R.

240

COBS 2.2.3R, as applied by COBS 2.2A.5R and see 3.4.4 below, which
includes some further specific commitments as regards engagement.

241

See Recommendation 3 and see also paragraph 3.28 of FS19/7,“Building a regulatory framework for effective stewardship” whichsays “most stakeholders felt that firms should exercise stewardshipbeyond listed equities. While they recognised that stewardship may
be easier to achieve in listed equities, which carry voting rights,
they argued that bondholders can still exercise influence. Some
respondents emphasised bondholders’ ‘important position in thecapital structure’. Accordingly, it was noted that bondholders canexert pressure before an investment is made – e.g. when setting
covenants and disclosure expectations – and when debt is beingrolled over.”242

Dear CEO Letter, from C. Gerken and A. Sweeney, Executive Directors,
Insurance PRA, “Insurance Stress Test 2019 and Covid-19 stresstesting: feedback for general and life insurers,” 17 June 2020, whichnotes that results from the exploratory climate scenario revealed
significant gaps in the industry’s capability to evaluate climaterelated scenarios, particularly in relation to the evaluation of climate
impacts on investments.

243

Page 13 of the Summary chapter.

244

Letter from Sam Woods “Managing climate-related financial risk
– thematic feedback from the PRA’s review of firms’ SS3/19 plans
and clarifications of expectations” (1 July 2020). Regulatory work
continues in this area. The Bank of England will also be issuing
additional guidance and useful material such as reference scenarios
prior to the launch of the 2021 climate focused Biennial Exploratory
Scenario. The PRA Response to the general insurance industry - aframework for assessing financial impacts of physical climatechange (20 November 2020) recognises that general insurers would
appreciate a framework for assessment of climate change risk on the506

asset side of their balance sheets similar to one it issued for them in2019 relating to the liabilities side.
245

The CFRF 2020 Guide, Risk Management chapter, page 52 notes that“countries will transition at different speeds. For example, it would
be unreasonable to expect countries such as China and Indonesia totransition at the same rate as, say, Germany and Denmark.”

246

CFRF 2020 Guide, Summary chapter, page 12.

247

Paragraphs 3.15 to 3.17 of SS19/3 say “longer term assessmentof the firm’s exposure, based on its current business model, of arange of different climate-related scenarios. For example: scenarios
based around average global temperature increases consistent
with, or in excess of 2 ˚C; and scenarios where the transition to a
low-carbon economy occurs in an orderly manner, or not. The PRA
expects the time horizon of this long-term assessment to be in theorder of decades…The PRA expects firms to use these scenarios tounderstand the impact of the financial risks from climate changeon their solvency, liquidity and…their ability to pay policyholders…
For insurers, Solvency II states that consideration of the long term isessential to insurers being able to assess their ability to continue as agoing concern.”

248This guidance is linked to insurers’ responsibilities under relevant
Principles for Businesses.

265

Shifting social and economic contexts may also help.

266

SYSC 3.2.23G(2); and similar for personal pension schemes in SYSC
4.1.15G(2).

267		Defined as “factors which are based on the views (including ethicalconcerns regarding environmental, social and governance issues) of
the firm’s clients or relevant policyholders.” As noted in relation to
the similar question which arises in relation to private sector pension
schemes (sese 2.2.43 above) the definition is not fully aligned withthe distinction in the 2014 Report between financial factors andnon-financial factors.
268

SYSC 3.2.23G(5)-(6); and similar for personal pension schemes in SYSC
4.1.15G(5)-(6). It is perhaps unfortunate that the rule is expressed on
an investment-by-investment, rather than a portfolio, basis.

269

COBS 19.5.7R(4) provides that a firm must have arrangements
to ensure that the views of relevant policyholders can be directly
represented to the IGC.

270

FCA “Reader’s Guide - an introduction to the Handbook,” page 11.

271

Investing with Purpose section 2.

272

Investing with Purpose page 7.

273

Investing with Purpose pages 17 and 19.

249

SYSC 3.2.23G.

274

ibid page 23.

250

A policyholder may nonetheless choose to take their businesselsewhere if they have concerns about the investment activities of
their existing insurer.

275

Some may appoint a specialist stewardship service provider.

276

Investing with Purpose pages 19 and 52.

277

Page 51 and there is a specific recommendation for investment
consultants “We urge consulting firms to provide more active
support to clients in raising the standard of their stewardship
activities, including client oversight of asset managers, client
engagement with managers on stewardship performance. Thisshould include consideration of alignment of stewardship approachof asset managers to the client’s stewardship needs as a factor in theselection and recommendation of asset managers” (Investing with
Purpose Recommendation 20).

251

Gaiman and Others v National Association for Mental Health[1971] Ch. 317 at [330].

252

The Rt Hon the Lord Millet, Michael Todd QC, and Alistair Alcock,
Gore Browne on Companies (Issue 155, Jordan Publishing, 2020),
chapter 15, paragraph. 10. See also GC100, “Guidance On Directors’
Duties Section 172 And Stakeholder Considerations,” 2018.

253

Section 172(1)(f) can be read to apply as between present and future
members as well as applying as between different classes of member.

254

In FS19/7 Building a regulation framework for effective stewardship,
the FCA (which is also the listing authority) said on page 13 “We also
note that the direction of travel in both public policy and industry
practice is towards a wider view of corporate purpose.”

255

Page 10 of the Risk Management chapter.

256

Although see 2.4.6(a)(vii) above and related endnote.

257

Section 260 Companies Act 2006.

258

As explained at 5.4.3 below, it is unlikely to be possible to amend
restrictive policy terms. However, amendment of disclosures may bepermitted by the FCA, subject to appropriate notice/publicity etc.
in relation to changes to the Principles and Practices of Financial
Management see COBS 20.4.

259

COBS 20.2.1.AR.

260

COBS 21.2.4.R.

261

Scottish Widows’ Exclusion Policy https://adviser.scottishwidows.
co.uk/assets/literature/docs/60307.pdf (accessed at 14 July 2021).

262

Aviva plc policy on cluster munitions 2015, https://www.aviva.com/
content/dam/aviva-corporate/documents/socialpurpose/pdfs/
policies-responses/04-2015-aviva-policy-on-cluster-munitions.pdf(accessed at 14 July 2021).

263

SYSC 3.2.23G; and similar for personal pension schemes in SYSC 4.1.15G.
Both are described as guidance under relevant Principles for Businesses.

264

FCA Policy Statement PS19/30 Independent GovernanceCommittees: extension of remit 17 December 2019 at 2.30-32.

278This includes understanding, for example, what screens andinvestment exclusions an Investment Manager may have in place aspart of its “house” policies.

279

This potentially involves balancing the interests of Beneficiaries
which may be impacted differently by the relevant stewardshipapproach. Damage might occur, for example, because those extra
activities increase the cost of the service being provided or because
they may unfairly impact on investment value or income in respectof one or more cohorts of the Asset Owner’s Beneficiaries.

280

Investing with Purpose pages 25 and 26.

281

Investing with Purpose recommendations 5 and 6.

282

Principle 4 is also mentioned at 1.13 above. We do not think itshould be read to suggest that signatories are expected to prioritisea well-functioning financial system above the best interests of theclients and beneficiaries although their interests could well bedamaged by a financial system that does not function properly (see“outcome” under Principle 1 and the passage from Reporting with
Purpose quoted in 3.1.5 above, which explains the inter-relationship).
Nor do we think that alignment necessarily denotes divestment,
not least because divestment reduces the ability to engage in
stewardship with the relevant company. See also pages 20 to 23 of
the FRC’s Review of Early Reporting under the Stewardship Code
(September 2020) https://www.frc.org.uk/getattachment/975354b46056-43e7-aa1f-c76693e1c686/The-UK-Stewardship-Code-Reviewof-Early-Reporting.pdf (accessed at 14 July 2021).

283

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Paragraphs 5.84 to 5.96 of the 2014 Report. The view expressed in
the preceding consultation document that all but the very largest
schemes lacked the internal resources or the financial clout to carry

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UNITED KINGDOMCONTENTSFOREWORDSINTRODUCTION
out effective stewardship was subject to considerable criticism,
which noted, in particular, that stewardship is often delegated.
284

Paragraph 5.98 of the 2014 Report.

285

Or, probably more accurately, the aggregated shareholding
controlled by its Investment Manager.

286

Direct costs include whether an Investment Manager charges higher
fees than alternative providers to cover the costs of its stewardshippractices, the costs of any direct engagement the Asset Owner
undertakes and costs incurred in understanding and interpreting
data on the relevant issues, or engaging investment consultants to
do so. However, there are also indirect costs too - see 3.1.17 below.

287

A small pension fund with small widely diversified stakes may wellreach different conclusions from a large one. There are avenuesof influence available even to smaller funds, including supportingcollective action. For example, the Association of Member
Nominated Trustees Red Line Voting initiative provides membernominated pension trustees with a guide to direct the voting ofInvestments Managers on ESG issues in relation to listed shares inpooled funds http://redlinevoting.org/ (accessed at 14 July 2021).
The initiative aims to make it easier for pension schemes to direct
their votes and to do so consistently across all fund managers it
has employed. It is also intended to make it easier for Investment
Managers to act in accordance with pension schemes voting
instructions by reducing the likelihood of receiving conflicting
instructions from multiple investors.

288

See S & P Global “Lights out for coal” https://www.spglobal.com/en/
research-insights/featured/coal (accessed at 14 July 2021).

289

Paragraphs 3.35 and 3.36. There are other statements by regulators
relevant to particular Asset Owners mentioned later in this section.

290

See, for example: 1) Financial Services Authority (the predecessor to
the FCA), open letter to the Institutional Shareholders’ Committee,
Shareholder engagement and the current regulatory regime 19
August 2009; 2) FCA, Towards more effective stewardship – “Speechby Edwin Schooling Latter, Director of Markets and Wholesale Policy
at the FCA, delivered at the LSE in London 23 March 2019,” 2019; 3)
FCA, Feedback Statement FS19/17, “Building a regulatory framework
for effective stewardship”, 2019, paragraphs 1.27-8.

291

292

293

294

507

See, for example, Consumer Detergents (Case COMP/39579),
Commission Decision of 13 April 2011, C(2011) 2528 final, paragraph
53. Draft guidelines by the Dutch competition authority suggest
a degree of willingness to examine the sustainability impacts ofcertain cartel-type agreements before deciding whether theseshould be permitted or not https://www.acm.nl/sites/default/files/
documents/2020-07/sustainability-agreements%5B1%5D.pdf(accessed at 14 July 2021).

Tomorrow’”, ACM/DM/2014/206028, 26 January 2015). See also, theDutch competition authority’s decision that the industry association
Energie Nederland’s plans to close down five coal power plants was
irreconcilable with Dutch and EU competition law (“Analysis by the
Netherlands Authority for Consumers and Markets of the planned
agreement on closing down coal power plants from the 1980s as
part of the Social and Economic Council of the Netherlands’ SER
Energieakkoord”, 26 September 2013). Conversely, see CECD (Case
IV.F.1/36.718) Commission Decision 2000/475/EC [2000] OJ L187/47
where the EU Commission held an agreement to discontinue lessenergy efficient washing machines did not infringe EU competition
law as it provided greater collective environmental benefits (asquantified in monetary terms) than the increase in costs.
295

296

For example, businesses impacted by a group of investors
collaborating to limit investment in non-green energy infrastructure.

297

https://www.gov.uk/government/publications/environmentalsustainability-agreements-and-competition-law/sustainabilityagreements-and-competition-law (accessed at 14 July 2021).

298

See Commission Notice 2001/C 3/02, Guidelines on the applicabilityof Article 81 of the EC Treaty to horizontal cooperation agreements,
OJ C 003 page 2, paragraph 185. Note, however, that the subsequent
iteration of these guidelines no longer separately addresses
environmental agreements (Guidelines on the applicability of
Article 101 of the Treaty on the Functioning of the European Union
to horizontal cooperation agreements, OJ C 11, page 1, paragraph18). These principles have been transposed into UK law following
the UK’s departure from the EU. The CMA provides guidance in its“Agreements and concerted practices guidance” (OFT 401).

299

See, for example, DSD (Case COMP/34493) Commission Decision
2001/837/EC [2001] OJ L319/1, paragraph 114.

300

The most progressive (draft) guidelines to date addressing theinterplay of competition law and collaborations for sustainability areby the Dutch competition regulator: https://www.acm.nl/sites/default/
files/documents/2020-07/sustainability-agreements%5B1%5D.pdf(accessed at 14 July 2021). The EU Commission is currently looking
into the same issues as part of the review of the two Horizontal
Block Exemption Regulations and the Horizontal Co-operation
Guidelines. Further guidance by other major authorities, suchas the US Department of Justice or the CMA, would contributesignificantly to the debate. The latter notes in its annual report for2021: “We are continuing to develop capability to ensure that when
delivering our statutory functions, we act in a way which supports
the transition to a low carbon economy” and “we will communicate
better to ensure that businesses engaged in sustainability initiatives
know how to comply with competition and consumer law and do
not unnecessarily shy away from those initiatives on the basis ofunfounded fears of being in breach of the law.”

See Chapter 1 section 9 of the Competition Act applicable toconduct with an impact in the UK market. Similar provisions exist
in other jurisdictions that operate a competition law regime (forexample, Article 101(3) TFEU).
Earlier in 2021, the CMA recently published an information
document to help firms navigate competition law when agreeing
to cooperate for the attainment of sustainability goals available
here: https://www.gov.uk/government/publications/environmentalsustainability-agreements-and-competition-law/sustainabilityagreements-and-competition-law (accessed at 14 July 2021).
More broadly, while there is some evidence of a changing
enforcement climate, enforcement cases to date have often taken avery formalistic approach. See, for example, the Dutch competition
authority’s 2015 decision the sustainability benefits produced by
the “Chicken of Tomorrow” animal welfare standards initiative
did not outweigh its anti-competitive costs and was therefore
irreconcilable with Dutch and EU competition law (“ACM’s analysisof the sustainability arrangements concerning the ‘Chicken of

See Joined Cases C-395 and 379/95P, Commission and France v.
Ladbroke Racing [1997] ECR I-6265, paragraph 33 and 34). See
also EU Commission decision in CASE AT.39258 – Airfreight, where
encouragement of coordination on fuel surcharges amongst airlines
by a civil aviation regulator was not accepted as a defence. The UK
CMA is unlikely to take action against companies pursuing initiatives
which are required under the UK’s legal commitments, but they
could take action where any competitor collaborations involveanti-competitive behaviour (e.g. information exchange) which goesbeyond what is strictly necessary to comply with the law.

301

302

Market Abuse Regulation (EU) 596/2014 OJ L 173, page 1, onshoredas UK MAR. See Part V of the Criminal Justice Act 1993 for thecriminal offence of insider dealing in England and Wales. See also
FCA, Feedback Statement FS19/7, “Building a regulatory framework
for effective stewardship,” 2019, paragraph 4.21.
FCA, Handbook: Disclosure Guidance and Transparency Rules
sourcebook: DTR 5.2.1R.

303

See Rules 4, 8 and 9.1 of the Takeover Code, but see also the
Takeover Panel, Practice Statement No 26 (Shareholder activism),2008; and ESMA’s “white list” of activities that shareholders may
undertake without being deemed to be acting in concert for the
purposes of Directive 2004/25/EC on Takeover Bids. (ESMA PublicStatement – Information on shareholder cooperation and acting inconcert under the Takeover Bids Directive, pages 5-6).

304

Sections 178, 181 and 422 FSMA.

305

Page 13 of FS19/7, “Building a regulatory framework for
effective stewardship”.

306

PERG 2.7.8G(1).

307

See PERG 10.3G question 16 “Am I going to be managing
investments by exercising voting rights conferred by investmentsthat I hold as trustee under my OPS? If so, will this be viewed as
my taking a day-to-day decision? No, you will not be managing
investments unless the exercise of the rights would result inyour buying, selling, subscribing for or underwriting securities orcontractually based investments. This will not usually be the case.
For example, voting to support a take-over offer to be made by
a company in which the scheme holds shares would not involve
managing investments as it would not result in your acquiring
or disposing of investments. Neither would voting on the reappointment of company directors or auditors or on whether acompany in whom the scheme holds shares should make a rights
issue (although deciding to subscribe to the rights issue when it ismade would amount to managing investments). Deciding to accept
an offer to buy company shares held by you under the scheme, inthe context of a proposed take-over of that company, would involve
managing investments. But the decision you make would be viewed
as strategic and not a day-to-day decision.” TPR has reinforced thisfor DB schemes in its investment guidance and for DC schemes in its
investment governance guidance.

308

Chapter 7, paragraph 2.

309

Paragraph 24.

310

TPR, “Investment governance” https://www.thepensionsregulator.
gov.uk/en/trustees/managing-dc-benefits/investment-guide-for-dcpension-schemes (accessed at 14 July 2021). The guidance goeson to provide an example of language for a SIP which sets out
in relation to the consideration of climate change as a financial
factor: “given the systemic nature of climate change, we will alsoseek to discharge our duties by robust engagement with investee
companies to encourage alignment with a low carbon economy
and with policy-makers and governments to advocate for the same.”
Similar guidance is provided in relation to DB schemes - TPR, “DBInvestment”.https://www.thepensionsregulator.gov.uk/en/documentlibrary/regulatory-guidance/db-investment/investing-to-fund-db(accessed at 14 July 2021). This is reinforced by paragraph 54 of the
PCRIG Guide 2020.

311

Investing with Purpose, page 23 and see also endnote 151 above.

312

Regulation 2(3)(c) Private Scheme Investment Regulations reflecting
article 3h SRD II.

313

Regulation 29A(1A) The Occupational and Personal Pension
Schemes (Disclosure of Information) Regulations 2013.

314

Recommendation 15.

315

LGPS Investment Regulations, reg 7(2)(f)). This is a narrower
requirement than private pension schemes are subject to stewardship goes well beyond the mere exercise of voting rights.
Notwithstanding this, The Environment Agency Pension Fund’s
Getting to net zero and building resilience Policy to Address Climate
Change states “We will…support shareholder activity to ensure thatcompanies manage their climate risk…support selective disinvestment
from holdings when engagement has not been successful andclimate risks remain and pose a financial uncertainty to the

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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investment. This includes the denial of new debt financing to suchcompanies as well as selectively disinvestment from equity holdings.”
316

COLL 6.6A.6R(1). “Exclusive benefit” may be a concept closer to a
duty of loyalty (see 1.19 above), than to “best interests”.

317

COLL 6.6A.6R(2)(a) and (b). COLL 6.6.3R(3)(b) provides “the authorised
fund manager must:(b) instruct the depositary in writing how rights
attaching to the ownership of the scheme property are to be exercised.”

318

COLL 6.6A.6R(3)(a) and (b). COLL 6.6A.6 reflecting article 21 of the
UCITS implementing Directive.

319

A firm is not required to disclose votes that are insignificant due to thesubject matter of the vote or the size of the holding in the company.

320

SYSC 3.4.4R to 3.4.7R, implementing articles 3(g)(1)(a) and (b) and (2)SRDII. An AFM can choose not to comply with these requirementsbut, if it does, must publicly disclose a clear and reasoned
explanation of why it has made this choice.

321

See further FCA’s February 2019 research note “Does the growthof passive investing affect equity market performance? A literature
review” by Kevin R. James, Daniel Mittendorf, Andrea Pirrone andClaudia Robles-Garcia.

322

However, stewardship by index funds is not necessarily thematic,
LGIM’s Active Ownership Report 2019 page 50 says “we engage withthe companies that can set an example in their sectors.”

323

See COLL 6.6A.2R(5); and COLL 6.6A.3G(2) (reflected in “Introduction(18)” - UCITS Implementation Directive).

324

325

ESMA, “Supervisory briefing on the supervision of costs in UCITS
and AIFs,” 2020 (ESMA34-39-1042). See also COLL 6.6A.3G(2) andRecital (18) of the UCITS implementing Directive (2010/43/EU). See
also COLL 6.6.20R (reflected in article 9 (3)(a) UCITS Implementation
Directive); and FCA, Policy Statement PS18/8, “Asset Management
Market Study remedies and changes to the handbook – Feedback
and final rules to CP17/18,” 2018.

See 1.17 to 1.24 above.

327

As noted in 3.1.16 above, if the public policy engagement is carriedout in collaboration with others (as it quite commonly would be- for example through PLSA or through a special interest group,
such as [Climate Action 100+] the costs will be shared with others.
Where the trustee is an incorporated professional trustee, with its
own resources, it may well decide that public policy engagement
undertaken at its own cost is appropriate for essentially its own
corporate purposes.

328

Investing with Purpose page 33.

329

Part II paragraph 48. See further, the Railpen example on page 23of the FRC’s Review of Early Reporting under the Stewardship Code
(September 2020) - https://www.frc.org.uk/getattachment/975354b46056-43e7-aa1f-c76693e1c686/The-UK-Stewardship-Code-Reviewof-Early-Reporting.pdf

508

331

SS3/19.

332

The latter occurs when all of the employer-sponsors of a scheme
enter insolvency processes, and during this period the PPF has
oversight of the scheme’s investment strategy, as it will potentiallyassume responsibility for providing a guaranteed minimum levelof benefits to members if at the end of the assessment period thescheme is not sufficiently funded to do this itself. In such a case the
PPF will take direct ownership and control of the scheme’s assets.

333

PROD 3.2.8R, 3.2.19R to 3.2.26R, 4.2.15R and 4.2.33R to 4.2.39EU.

334

This focus is reflected in industry guidance: UK Finance, Guidelines:
MiFID II Product Governance: Guidelines on Target Market
Identification, 2017; and IA, MiFID II product governance: qualitative
information requirements for the regular product review, 2019.
ESMA guidance, to which the PROD section of the FCA Handbook
refers, states that where the product has “specific investment
objectives such as…‘green investment’ [and] ‘ethical investment’”,
these objectives should be included in the target market
specification (ESMA, Guidelines on MiFID II product governancerequirements, 2018, paragraph 18(e)). The FCA has made similarstatements to the ESMA guidance, although not in formal guidance:
see FCA, Feedback Statement FS16/11: Call for Input: Regulatory
Barriers to Social Investments, 2016, paragraph 1.12.

335

336

SYSC 3.4.4R to 3.4.7R, implementing articles 3(g)(1)(a) and (b) and (2)SRDII. An insurer can choose not to comply with these requirementsbut, if it does, must publicly disclose a clear and reasoned
explanation of why it has made this choice.

326

330

Parliamentary time allow” (quoted in Benjamin Mercer, “LGPS wades
into Israel-Palestine row with UN blacklist engagements,” PensionsExpert.com, 2 October 2020).

See, for example R (on the application of Palestine Solidarity
Campaign Ltd) v Secretary of State for Housing, Communities andLocal Government [2020] UKSC 16 and ongoing debates aroundthe appropriateness of certain LGPS fund policies in relation toinvestment in Israel, on which the Ministry of Housing, Communities
and Local Government has stated that: “The Government is firmly
opposed to local boycotts, which can damage integration andcommunity cohesion, hinder exports, and harm foreign relations
and the UK’s economic and international security. Councils should
not impose boycotts that could undermine foreign policy, which isa matter for the UK Government alone…We will legislate as soon as

337

TPR, “A guide to Investment governance,” June 2019, page 14: “Indetermining the investment principles for your scheme, you may
in certain circumstances choose to consider factors which are notfinancially material to your scheme. These could include offering
funds that select investments according to particular religious
principles or are based on environmental or social impact.”
Law Commission, Fiduciary Duties of Investment Intermediaries,
2014, Law Com No 350, paragraph 6.36, see also at paragraph 6.85:“there are two clear exceptions where significant financial detrimentis permitted: (1) Where the decision is expressly permitted by thetrust deed; and (2) In DC schemes, where members may choose toinvest in a specific fund.”Section 236A FSMA. As a matter of UK law, it must also meet thedefinition of a collective investment scheme. Section 235(1) FSMA
defines “collective investment scheme” as “any arrangementswith respect to property of any description, including money, thepurpose or effect of which is to enable persons taking part in thearrangements (whether by becoming owners of the property or any
part of it or otherwise) to participate in or receive profits or income
arising from the acquisition, holding, management or disposal of
the property or sums paid out of such profits or income.” It therefore
appears that it should also enable a financial return, especially as
an UCITS may only invest in transferable securities or other liquid
financial assets (see further section 236A). COLL 3.2.6R(7) requires
a UCITS’ constitution to include “a statement that the object of thescheme is to invest in property of the [relevant] kind with the aim of
spreading investment risk and giving unitholders the benefits of theresults of the management of that property” (based in part on article
1(2) UCITS Directive).

338

OEIC Regs 2001, reg 15(10) and section 243(9) FSMA.

339

COLL 3.2.2R(1)(c).

340

See, for example, FCA, Feedback Statement FS16/11, “Call for Input:
Regulatory Barriers to Social Investments”, 2016, paragraph 1.6 and
FCA, Policy Statement PS19/4, “Asset Management Market Study further remedies,” 2019, paragraphs 29 and 30.

341

As confirmed by Richard Monks, Director of Strategy at the FCA,
in his speech at the SRI Services and Partners “Good MoneyWeek” Panel https://www.fca.org.uk/news/speeches/building-trust-sustainable-investments (accessed at 14 July 2021).
342

See the Investment Association “Fund communication of
responsible investment”.

343

COLL 4.2.5R(3)(c-a) and 4.2.5R(27)(a).

344

UCITS Directive, article 78(5); COLL 4.1.2G; COLL 4.2.5R(3)(c-a); COLL
4.7.2R(7) (article 78 (5) UCITS Directive); 6.3 (article 85 UCITS Directive);and 6.6A.2R(4) (article 8(3) UCITS Implementation Directive).

345

For example: 1) ESMA final report on integrating sustainability into
UCITS Directive and AIFMD, April 2019, paragraphs 27-29 and 40; 2)
Opinion of the Securities and Markets Stakeholder Group, quoted
in the Annex 5 to the ESMA final report on integrating sustainability
into UCITS Directive and AIFMD, April 2019; 3) European Supervisory
Authorities, joint consultation paper on ESG disclosures, April 2020,
page 72; 4) FCA, consultation paper on climate-related disclosuresby listed issuers (CP20/3), 2020, paragraphs 2.19 and 5.3; and 5)
FCA, Feedback Statement on Call for Input: Regulatory Barriers toSocial Investments (FS16/11), 2016, paragraph 2.24. See discussionof similar concerns in Law Commission consultation paper no 216,
Social Investment by Charities, 2014, paragraphs 6.11 to 6.13.

346

COLL 6.6A.4R (article 23(2) UCITS Implementation Directive). See
also article 7(1)(b) UCITS Directive, which requires that “the persons
who effectively conduct the business of a management company
are sufficiently experienced also in relation to the type of UCITS
managed by the management company.”

347

COLL 6.6A.2R(4) (article 8(3) UCITS Implementation Directive); and6.6A.4R (article 23 UCITS Implementation Directive).

348

For example, “Building trust in sustainable investments”: speech byRichard Monks, Director of Strategy at the FCA, 21 October 2020;
FCA FS16/11, feedback statement on Call for Input: Regulatory
Barriers to Social Investments, paragraph 2.24.

349

OECD report, “Investment governance and the integration ofenvironmental, social and governance factors,” 2017, page 21(accessed at 14 July 2021).

350

As regards FCA approval, see regulation 21 Open-ended Investment
Company Regulations 2001 (SI 2001/1228) and section 251 FSMA. As
regards unitholder approval, see COLL 4.3.4R to 4.3.7G (Article 44 UCITS
Directive). A “fundamental change” includes one which (a) changes
the purposes or nature of the scheme; (b) may materially prejudicea unitholder; or (c) alters the risk profile of the scheme. See also The
Investment Association, “Member Guidance, Authorised Funds: A
Regulatory Guide,” 2017, page 14., which gives the example of achange in investment policy or objective as a fundamental change.

351

COLL 4.3.4R to 4.3.7G (Article 44 UCITS Directive).

352

Insurance-based investment products as defined in Directive (EU)2016/97 of the European Parliament and of the Council of 20
January 2016 on insurance distribution, OJ L 26, Article 2(1)(17).

353

Regulation (EU) 1286/2014 of the European Parliament and of theCouncil of 26 November 2014 on key information documents for
packaged retail and insurance-based investment products, OJ L 352,
Article 8(3)(c).

354

SYSC 3.2.23G(6).

355

I.e. factors which may influence a firm’s investment strategy or
decision, and which are based on the views (including ethical concerns
regarding environmental, social and governance issues) of the firm’sclients or relevant policyholders. This definition, in our view, could
encompass policyholders’ views on sustainability impact objectives.

356

FCA, Policy Statement PS19/30: Independent GovernanceCommittees: extension of remit, 2019, at paragraph 2.2.36. This is
likely because, as the 2014 Report points out at paragraph 8.33 there
is no “point of sale” in relation to these products.

357

Typically, express provisions are limited to the exercise of voting

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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rights. Investing with Purpose says (at pages 51 and 52) “while
managers are starting to see stewardship expectations feature incontractual arrangement more often, this is by no means the norm…
Investment managers do not always have a clear view of their client’s
stewardship priorities.”
358

359

Generally, an Investment Manager will seek to have a comprehensive
statement of requirements in its IMA so that it does not need tolook at underlying trust deeds, policies or regulations applying to the
Asset Owner.
COBS 2.1.2R limits the extent to which an Investment Manager may
exclude its liabilities. There are additional limits in relation to “retailclients”. A local authority pension fund falls within the definitionof “retail client” but, in practice, is likely to opt up to the status of“professional client”.

360

COBS 9A.

361

In respect of a professional client, the Investment Manager is entitledto assume it has the requisite level of experience and knowledge itwould otherwise be required to obtain appropriate information about.

362

The SFDR MiFID Implementing Directive adopted by theCommission on 21 April 2021 as part of the EU’s Sustainable FinancePackage amends the MiFID suitability provisions underlying thisrule so as to require an Investment Manager to seek information
about its clients’ sustainability preferences. Although the UK will
not be required to implement this directive, it is assumed that the
FCA will at least consider doing so as part of its UK Green Taxonomy
proposals (see the FCA’s Regulatory Initiatives Grid of May 2021).

363

Section 36 Pensions Act 1995.

364

By contrast, it is unlikely that there would generally be a sufficiently
close relationship of trust and confidence between an Investment
Manager and the beneficiaries of a pension fund client for theManager to owe fiduciary duties to beneficiaries directly (seeparagraphs 10.21 to 10.29 of the 2014 Report for a more detailed
discussion of the position of an investment manager).

365

Subject, where the Asset Owner is a private sector scheme, tosection 33 Pensions Act 1995.

366

COBS 2.2.3R, as applied by COBS 2.2A.5R.

367

The investment division of the Association of British Insurers
merged with the Investment Management Association to form theInvestment Association in 2014.

368

Note, however, that some obligations referred to above (e.g. under
the Pensions Act 1995) cannot be overridden by the IMA.

369

See PRIN 2.1.1R(3).

370

The CEO of Blackrock’s 2020 letter to portfolio companies said “ourinvestment conviction is that sustainability- and climate-integrated
portfolios can provide better risk-adjusted returns to investors.
And with the impact of sustainability on investment returns
increasing, we believe that sustainable investing is the strongest
foundation for client portfolios going forward. In a letter to ourclients today, BlackRock announced a number of initiatives to placesustainability at the center of our investment approach, including:making sustainability integral to portfolio construction and risk
management; exiting investments that present a high sustainabilityrelated risk, such as thermal coal producers;…and strengthening ourcommitment to sustainability and transparency in our investment
stewardship activities.” His 2021 letter returns to this theme andends by saying “we face a great challenge ahead. The companies
that embrace this challenge – that seek to build long-term value
for their stakeholders – will help deliver long-term returns toshareholders and build a brighter and more prosperous future forthe world.”

371

509

372

Vanguard 2019 statement on compliance with the Stewardship Code.

373

Annex 5 of PLSA’s publication “Pension scheme implementation
guidance not reporting template for asset owner” includes a list of
potential stewardship conflicts.

374

See page 34 of the Risk Management chapter.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY375

See policy described in endnote [153] and Scottish Widows example
in 2.4.28 above.

376

In its Active Ownership Report 2019, LGIM notes that it chooses toengage with portfolio companies that can set an example in their sector.

377

State Street Global Advisors 2020 Asset Stewardship Report, page
45 and policy and collaboration section of LGIM’s Active Ownership
Report 2020.

378

Statement of Compliance with the Stewardship Code by BMO
Global Asset Management EMEA (November 2018).

379

Lazard Asset Management Annual Sustainable Investment Report2020 (pages 46 and 47).

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSI380

State Street Global Advisors Stewardship Report 2020 and policy
advocacy and collaboration section of LGIM Active Ownership
Report 2020.

C. AREAS FOR LEGAL REFORM

381

See, for example, Blackrock’s statement on compliance with the UK
Stewardship Code.

382

Liability under the Environmental Protection Act 1990 exists under abespoke regime which could be considered generally civil in nature,
in attempting to ensure remediation rather than impose liability.
Nonetheless, an enforcing authority can serve a notice to require
remediation of contaminated land and a failure to comply with a
notice can amount to a criminal offence under the Environmental
Protection Act 1990, section 23(1)(c).

383

Lungowe v Vedanta Resources Plc & another [2019] UKSC 20 at 52.

384

Caparo Industries PLC v Dickman [1990] 2 AC 605.

385

We note that where an Asset Owner is involved directly in lending
activity (so-called “shadow banking”), there may be a closer nexus
between the Asset Owner (as lender) and the activities of theportfolio company, which may have a negative sustainability impact.
This may increase the possibility of a successful claim in negligence– for example, where a loan for a particular activity which ultimately
caused a negative sustainability impact was given negligently, on thebasis that it was reasonably foreseeable that the activity for which theloan was granted would result in a negative sustainability impact.

A. INVESTING FORSUSTAINABILITY IMPACT

ANNEXESJURISDICTION REPORTS

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FranceJapan

386

They may also serve to highlight any shortcomings in thosearrangements and motivate the Asset Owner or Investment Manager
to address those shortcomings.

387

In the case of shareholders in insurers, they already receive this kindof information in the form of the insurer’s annual accounts.

388

See “Aviva chief warns insurers on ‘forked tongue’ over climatechange,” Financial Times, 1 March 2021.

United Kingdom

389

Charities, NGOs and other interested parties have also usedalternative means to draw attention to ESG-related actions (orinaction) by corporates, including through references to theAdvertising Standards Agency (for example, challenging airlines formaking “lowest emissions” claims, although we are not aware of any
such challenges having been brought against Relevant Investors todate in relation to their investment strategies) and through asking
questions and proposing shareholder resolutions in fora such as
annual general meetings.

United States390

Netherlands

South Africa

GLOSSARY
REFERENCES

See, for example: OECD Watch Case Database, Milieudefensie/
Friends of the Earth Netherlands v ING Bank, 2019.

Blackrock January 2020 statement on compliance with the
Stewardship Code.

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UNITED STATESCONTENTSFOREWORDSINTRODUCTION

1.

INTRODUCTION

1.1

For the purposes of this annex, we haveconsidered relevant U.S. federal or statelaws and regulations in effect on March
31, 2021. Sections 2–4 discuss whether
Asset Owners are required or permitted to“Invest for Sustainability Impact” (“IFSI”)
when the portfolio being managed by therelevant Asset Owner is not subject to an
explicit IFSI investment objective. Section
5 considers whether newly offered ororganized funds can be established within
the current U.S. legislative frameworkthat have an explicit IFSI investment
objective. Sections 6 and 7 consider an
Investment Adviser’s1 duties to IFSI andwhether any legal liability may arise tothird parties for negative Sustainability
Impact, respectively. Section 8 considers
the growing importance of taking into
account environmental, social andgovernance (“ESG”) factors where thesefactors have implications for an investor’s
duty to achieve its financial investment
objective that are financially material.

1.2

510

As discussed in the main body of thereport, the expression “Investing for
Sustainability Impact” is not a precisely
defined legal term. It is important toemphasize that, to the extent there are
any applicable federal or state laws or
regulations in the United States, theselaws do not reference the IFSI concept.
The expression is used in this Annex as aconceptual framework in order to describe
any legal duty or authority on the part ofAsset Owners or their Investment Advisersthat could lead them to pursue one or

ACKNOWLEDGEMENTS

more Sustainability Impact objectivesof any sort, whether in order to achieve
their financial objectives by protecting or
enhancing the financial performance ofinvestments (“instrumental IFSI”) or inorder to achieve economic, environmental
or social benefits where this is motivatedby a purpose other than protecting or
enhancing the financial performance ofinvestments (“ultimate ends IFSI”). An
example of instrumental IFSI would be
the goal of securing behavior change on
the part of investee enterprises that canhelp to avert an aspect of the climate
crisis, thereby reducing systemic/nondiversifiable risk to an entire portfolio inorder to assist the investor in pursuing
its legally required financial goal(s). In
contrast, ultimate ends IFSI is the pursuitof a sustainability impact goal for any
reason other than seeking to achieve
the investor’s legally required financial
goal. Often under U.S. literature andadministrative guidance, the activities ofinvestors that fall within the concept of“instrumental IFSI” will be referred to as“economic return investing” (althoughthat expression also refers to a wider
range of investment activities), andactivities of investors that fall within
the concept of “ultimate ends IFSI”
will be referred to as “collateral benefit
investing.” For the purposes of thisannex, we have elected to use our IFSI
terminology to ensure consistency acrossthe report.

1.3

1.4

We have not found any U.S. federal orstate law or regulation that would requirean Asset Owner or Investment Adviser topursue ultimate ends IFSI without regard
to financial return. Although there may
be some cases where ultimate ends IFSI
is permissible (subject to prioritizing theachievement of financial return), thereality of the litigious environment in
the United States likely means that Asset
Owners and their Investment Advisers
will need to determine prior to taking any
action whether or not a litigator could
successfully posit a causal link between
such activities and any adverse impact
on financial return and thereby provea breach of their duties as a result of
pursuing such activities.
The concept of this difference between
actions motivated exclusively by financial
return considerations and those motivatedby wider-ranging considerations ispresent in discussions in the U.S. market,
including in the form of guidanceissued by the U.S. Department of Labor
regarding integration of ESG factors in theinvestment process.2 Very broadly (since
this is discussed more fully below), thecurrent understanding, especially in thecontext of pension fund management,is that where an environmental, social
or governance factor has material
implications for the realization of aninvestor’s financial investment objective,then the investor will be under a duty
to take it into account appropriately inthe way it seeks to discharge its duties to

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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UNITED STATESCONTENTSFOREWORDSINTRODUCTION

pursue that financial objective. However,where an ESG factor does not havematerial implications, then it will only
be possible to take it into account in theway a portfolio is managed in limited
circumstances, if ever.
1.5

In this annex, certain underlying key
themes recur:

Distinction between federal and state law
1.6

The U.S. system of laws and regulations
is bifurcated into a two-tier system
consisting of federal and state law. Federallaw, in almost all cases, supersedes statelaw. The laws and regulations that apply
to different Asset Owners vary greatly,
and it is important to determine whether
the Asset Owner is regulated by federallaw, state law or both. Each of the 50 U.S.
states has its own laws, and the sections
that apply to state laws in this annex do
not purport to be a full 50-state survey.
Accordingly, the discussions below onstate law are for illustrative purposes onlyand set out some of the more high-profilestate laws in order to illuminate the divide
between federal and state law.

Considerations of instrumental and ultimate ends
IFSI
1.7

511

example, even when applicable laws,
regulations or guidance do not explicitly
regulate ultimate ends IFSI, the abilityof an Asset Owner or Investment Adviser
to engage in ultimate ends IFSI may becurtailed by the fiduciary duties to which
they are subject requiring them to focus
on and prioritize financial return.

As discussed further below, forcertain types of Asset Owners, making
investment decisions in any mannerthat is not focused on achieving theirfinancial objectives by protecting or
enhancing the financial performance ofinvestments is either inconsistent withexisting or proposed laws, regulations orinterpretative guidance, or only permitted
in a limited set of circumstances. For

1.8

However, the question of whether agiven course of action is ultimate ends
IFSI rather than instrumental IFSI may
not be entirely straight-forward. In
particular, the possible need for an Asset
Owner or Investment Adviser to take into
account different underlying investor
time horizons can result in a need forcomplex judgements as to whether it islegally required or permitted to engage in
IFSI. It is possible that pursuing a given
Sustainability Impact goal might help in
mitigating systemic risk to the financial
performance of a portfolio in the longterm and thereby support the realizationof an Asset Owner or Investment Adviser’s
financial investment objectives over that
period. However, in considering whether
to act, the Asset Owner or Investment
Adviser would need to weigh various
factors. These include duties to investors
that could be affected by the negative
effect (if any) of pursuing that impact
goal on investment performance in the
short-term. In addition, the Asset Owneror Investment Adviser will need to weighwhether short-term benefit foregone (ifany) as a result of pursuing the impact
goal would be sufficient to off-set theeffect of potential future loss of value
or opportunity if the relevant systemicrisk is not mitigated. In either case, thisnecessitates an analysis of how an Asset
Owner or Investment Adviser must
balance potential conflicting interests ofdifferent investors in the same asset pool.
1.9

Given the litigious nature of the UnitedStates, Asset Owners and Investment
Advisers will be aware that they need
to be in a position to provide legally
acceptable reasons for any course ofaction they take, whether in relation to
IFSI or otherwise; this includes as to its
cost and impact or potential impact on
investment returns over the relevanttime period or periods and by reference
to, potentially, different generations ofunderlying beneficiaries. That said, as apractical matter, especially in the caseof stewardship and policy engagement,
it could be difficult for a litigious
investor to prove a causal relationshipbetween the action of the Asset Owneror Investment Adviser and any negative
impact on financial performance(assuming that the costs and expensesof stewardship and policy engagement
are not disproportionately material tosuch performance), particularly since theAsset Owner or Investment Adviser will
not be responsible for implementing any
change that is the subject of the action.
While the possibility of claims may be
more foreseeable in the event of financial
underperformance, there may also be arisk of investor litigation should an Asset
Owner or Investment Adviser take noaction whatsoever in response to the risks
posed by sustainability factors.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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1.10

512

Because of the complex considerations
involved in delineating IFSI fromtraditional investment practices, andthe lack of explicit guidance in many
aspects of the U.S. regulatory system inconsideration of IFSI, we anticipate that
Asset Owners or Investment Advisers
may be more cautious about using theirinvestment powers to pursue instrumental
IFSI as compared to exercising theirstewardship powers. We take this view
because we anticipate that the use ofinvestment powers may have more
direct implications for the financial
performance of a portfolio, at least in the
short-term. In the meantime, especiallyin public markets, where Asset Owners
or Investment Advisers conclude thatsustainability factors represent a risk
to the achievement of their financial
investment objectives (or that they may
present opportunities), it may be more
likely that they will conclude that taking
appropriate stewardship action, rather
than the exercise of their investment
powers, represents the best avenue fordischarging their standard of care in amanner that produces verifiable results(whether as a result of changes in thecomposition of the board of directors or
corporate strategy of entities in which
fiduciaries invest or otherwise). Thatsaid, the exercise or possible exercise
of investment and divestment powers
in that context might provide a way ofstrengthening their communications withthe company and its directors.

1.11

Whether using investment powers,
stewardship or undertaking policy
engagement, Asset Owners or Investment
Advisers considering pursuing
Sustainability Impact goals will need toaddress challenges in terms of defining
those goals and assessing progress
towards them and their potential financial
implications (and how these can assist
in seeking to achieve their financial
objectives), and establishing a robust
understanding of how they can best bring
their influence to bear. This may leadthem to focus on areas where there isgreater investment community consensus
and clearer policy direction on thesematters.

duty of loyalty, a trustee must consider
only the interests of the beneficiaries.5
Accordingly, a trustee’s use of ESG factors,
if motivated by the trustee’s own ethicaljudgment regarding the need to obtaincollateral benefits for third parties orassumptions regarding the collective
will of its beneficiaries without formallysoliciting their views in accordance withthe terms of the trust, will violate theduty of loyalty. Under the sole interest
rule, a trustee violates the duty of loyalty
if the trustee has any motive or rationale
for undertaking an action other thanthe “sole interest” or “exclusive benefit”
of the beneficiary. A trustee who is
influenced by the trustee’s own or athird party’s interests is disloyal, because
the trustee is no longer acting solely
in the interest of the beneficiaries. The
sole interest rule imposes a categoricalprohibition, with “no further inquiry”
into whether a conflicted transaction wasfair. It has historically been applied in acontext in which a conflicted transactionis unlikely to be beneficial and beneficiary
monitoring of the activities of the trustee
is weak. Paragraph 1.15 below discusses
this rule in the context of ultimate ends
IFSI.

Sole interest rule in trust fiduciary law vs. bestinterests rule in corporate law3
1.12

1.13

The trustees of retirement assets,
retirement plans, pension funds, public
pension plans, public pension funds andprivate retirement plans generally owe
fiduciary duties to beneficiaries of thetrust. In crafting an investment strategy,
trustees must carefully evaluate theiractions in light of their fiduciary duties,some of which are statutory, someof which are contained in regulatory
guidance and others that result fromdecisional law interpreting statutes andregulations. Fiduciaries are largely unable
to contract out of their fiduciary duties,4and accordingly are highly reluctant
to pursue an investment strategy that
subjects them to potential legal liability.
Under the “sole interest rule” of trust
fiduciary law, which is derived from the

1.14

A different rule applies in the context
of corporations where management of
those entities are bound by a different
type of loyalty. Under this duty of loyalty,
a fiduciary is not categorically prohibitedfrom acting with a conflict of interest,
but rather must act in the “best interest”
of the principal. The best interest ruleis satisfied if and to the extent that

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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UNITED STATESCONTENTSFOREWORDSINTRODUCTION

actions by a fiduciary that are in the
self-interest of the fiduciary are also,with sufficient frequency, in the bestinterests of the principal; accordingly,
the principal is better off with an
enquiry into whether self-interested
transactions pass an “entire fairness” test.
As discussed further in Paragraph 2.5.9
below, the “entire fairness” test considers
whether a transaction is entirely fairto stockholders, considering both theprocess and price of a transaction. Thisis especially likely if the fiduciary (e.g., acorporate board of directors) was chosen
for professional expertise that overlaps
with the fiduciary’s personal interests.
Transactions that do not satisfy theentire fairness test will likely come to theattention of investors and therefore be
subject to effective challenge.
1.15

513

In relation to trusts, as discussed ingreater detail below, instrumental IFSI
can be consistent with trust fiduciary law
when the fiduciary’s “sole” or “exclusive”
motive in doing so is to seek to achieve
the financial investment objective of thetrust. If motivated solely by this purpose,
an instrumental IFSI investing strategy
satisfies the sole interest rule. In contrast,
ultimate ends IFSI will not satisfy thesole interest rule under trust fiduciarylaw—simply because it does not prioritizeachieving the financial objective of thetrust.6 Even if ultimate ends IFSI werepermitted or required under applicable
U.S. federal or state law, the pursuit ofultimate ends IFSI7 could face a numberof practical challenges that could inhibit
Assets Owners or Investment Advisersfrom engaging in it. These may include
the following: (a) an investor base is likely
to include a diverse group of individuals
with different conclusions and beliefs
about appropriate collateral goals (sothat the beliefs of some are likely toconflict with all or some of the ultimate
ends pursued by a fiduciary), (b) at thetime of writing, there is no commonly
established mechanism to allow investors
to express their preferences with respect
to collateral goals and how to transmit
them to the fiduciary and (c) the inability
to demonstrate a link between investment
decisions made and the achievement ofapplicable financial investment objectives,
if such decisions produce (after fees andexpenses) returns materially below thosegenerated by other investment advisers
over a selected period. Any such decisions
will likely be challenged by investors on
a post hoc basis in a litigious society suchas the United States (making fiduciaries
potentially unwilling to bear this risk).
U.S. social and political context
1.16

Although at this point it is too early
for the Biden administration to have
implemented significant specificregulatory changes, early indications
suggest that there will be a renewed
focus on climate and ESG issues acrossfederal agencies,8 especially in light of
the Covid-19 pandemic and accelerating
manifestations of the climate crisis,both of which have arguably put therelationship between ESG factors andfinancial returns in the spotlight.9 There
are two main ways that ESG investing
may change as a result: (a) the debate overits economic value will be re-examinedin light of any outperformance of ESGoriented portfolios and companies during
the crisis and thereafter and (b) the
broader conversation on social inequities
and systemic racism that intensified
during the pandemic have arguably (i)increased investor awareness of the ways
in which sustainability can affect theirinvestments, (ii) bolstered investor support
for socially responsible corporate policies
and (iii) shifted investors’ prioritization of
Sustainability Impacts in the short-term,
for example toward a greater emphasis on
the treatment of employees and mattersthat affect health and safety.
1.17

The U.S. Securities and Exchange
Commission (the “SEC” or the“Commission”) has acknowledged
increased investor demand for ESG
products10 and the importance of
disclosing material ESG and climaterelated risks to investors. On March 4,2021, the SEC announced the creation ofa “Climate and ESG Task Force” within
the SEC Division of Enforcement, theinitial focus of which will be to “identify
any material gaps or misstatements inissuers’ disclosure of climate risks under
existing rules.”11 The move was followed
by a number of announcements fromthe Commission on the SEC’s renewed
focus on climate and ESG-related risks,
including comments from then-Acting
Chair Allison Herren Lee that “climate
and ESG are front and center for the SEC”
given increased investor prioritization ofthese issues and a request for commentsfrom market participants on climate

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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change disclosure.12 In his March 2021
confirmation hearing before the Senate,
the now-current chair of the SEC, Gary
Gensler, responded to critics of ESGrelated investing by stating that “it’s theinvestor community that gets to decide
what’s material to them.”13 This recent
focus on monitoring and regulating
ESG-related disclosures is currently
positioned within the existing framework
under U.S. federal securities laws, which
requires disclosure of all material risks
to investors. The acknowledgement of
the growing importance of ESG factors toinvestors and enforcement against issuersthat fail to make appropriate disclosures
will likely encourage Asset Owners to takethese factors into account, at least where
they potentially have material financial
implications, when seeking to achieve
their financial objectives.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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2.

ASSET OWNERS’ USE OF POWERS OF INVESTMENT AND DIVESTMENT TO IFSI

2.1

The following section considers the extent
to which and in what circumstances eachtype of Asset Owner is (a) legally requiredor (b) legally permitted or able to use its
powers of investment and divestment to
IFSI.

2.2

Retirement funds
Asset Owner: Retirement funds (including
public funds and private retirement
plans such as tax-efficient 401(k) and IRA
plans) are the legal owners of the assets.
These funds can manage assets directly oroutsource management to an investment
decision-maker.
Beneficiary: Current pension plan
participants, as well as persons designatedby a participant to receive some or all of
the participant’s pension benefits.
Investment decision-maker: Investment
or asset manager that acts on behalf of theAsset Owner. The investment decisionmaker is often a trustee of the fund,although many trustees delegate all orpart of their responsibility for investment
decisions to third-party Investment
Managers with respect to all or a portionof the fund assets.

Types of retirement funds covered
2.2.1

515

A retirement fund is any employee benefit
plan established or maintained by an
employer or by an employee organization(e.g., a labor union), or both, that provides
retirement income or defers income until
termination of covered employment or alater date.14 Retirement funds represent
some of the largest investment poolsin the United States and can generally
be categorized as either public pension
funds or private sector retirement plans,
depending on whether plan participants
are employed in the public or private
sectors. Retirement assets or plansinclude:(a) Defined benefit plans (often referred toas pension funds), where, as a generalmatter, the plan sponsor (or its delegate)
selects the investments for the plan’sassets and the beneficiaries receive a predetermined benefit paid out of investment
proceeds that is calculated in advanceusing a formula based on age, earnings
and years of service to yield a lump sum
or periodic hybrid payment schedule; and(b) Defined contribution plans (often
referred to as individual retirement
plans), where, as a general matter, plan
participants acting in their own discretionare permitted, through an individual’s
account under the plan, to select certain
funds from a group of external mutual
funds and other investment vehicles
vetted and selected by or on behalf of
the Asset Owner in which they may
invest their portion of the plan’s assets.
Unlike defined benefit plans, there
is no specific benefit participants areentitled to and returns vary based on
the value of investments. The majority
of defined contribution plans are fundedby employee contributions out of pre-tax
income, subject to an annual maximum
contribution amount that is mandated bylaw. Beneficiaries choose how to invest

their contributions from a list of mutual
funds and other investment vehicles
selected by the fund trustee. These defined
contribution plans have tax benefits andcontributions are sometimes matched by
employers. Defined contribution plans
may be funded through participants, theiremployer, or both.
2.2.2

2.2.3

Public pension funds are subject to stateand local laws regarding administrationand investment and collectively managed
by or on behalf of participating employees.
In the U.S., public pensions are offered atevery level of government and are widely
available to most public sector employees.
State pension plan contributions
are generally made by participating
employers, which can include stateand local government or governmental
agencies, school districts and public
universities or other local government
entities. Together, we refer to these funds
in this report as “public pension funds.”
Private retirement plans take many forms
and are established or maintained byprivate employers for the benefit of theiremployees. Unlike public pension funds,
private retirement plans are regulated byfederal law. Some employers voluntarily
offer access to their own independently
established pension funds, while others
do so because they are required to provide
access to pension funds (which may becompany-specific or industry unionspecific) under the terms of collective
bargaining agreements that are generally
entered into with organized labor

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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UNITED STATESCONTENTSFOREWORDSINTRODUCTION(i.e., unions such as the autoworkers).
They are commonly defined benefit plans.
Private retirement plans also include
private defined contribution plans, as
described above in Paragraph 2.2.1(b). In
such plans, a framework for investingwith certain tax benefits is establishedand maintained by employers and offeredto their employees, and those who wish
to save for their retirement are given theability to set up individual retirement
accounts. The employer holds back a partof the employee’s salary (tax-deferred) andplaces it into a fund for investment thatthe employee can access at retirementage. Some employers are willing tomatch, in whole or part, contributions
made by their employees. There arealso private individual retirement plansthat are not maintained by or affiliatedwith employment but are structured orotherwise incentivized by the federal
government to provide tax benefits andremain in the control of the investors;
these private plans are not otherwise
discussed in this report.
2.2.4

516

Both employer and individual retirement
plans generally are funded by voluntary
employee contributions out of income,with certain exceptions, such as (a) defined
benefit plans sponsored by governmental
entities for their employees’ benefit thatare required under federal, state or local
U.S. law, to which public employees areoften required to contribute, and (b)private sector defined benefit plans, which
are often funded exclusively, or matchedin part, by employer contributions.
Contribution amounts for each employee

are generally subject to an annual
maximum contribution amount that is
mandated by law.
2.2.5

All retirement funds, both public andprivate, are held in trust. A fund’s trustee
holds title to the assets in the fund and issubject to fiduciary duties in managing
the assets.

Overview of investment duties and powers – public
pension funds
2.3

2.3.1

Public pension funds are subject tofederal, state or local laws and regulations
regarding the establishment andadministration of pension funds for the
relevant federal, state or local public
sector employees and are collectively
managed by or on behalf of participating
employees.
Trustees of public pension funds are
subject to certain rules and fiduciary
duties derived from common law, whichhave largely been incorporated into statestatutes. These obligations include the soleinterest rule, the prudent investor ruleand the duty of impartiality.

Sole interest rule
2.3.2

Most state laws contain language that
require a trustee to act in the “soleinterest” of their beneficiaries. Virtually
every state has similar language
mandating its pension trustees to act inthe “sole interest” of their beneficiaries.
“Interest” has been interpreted to mean
financial interests, as discussed further
below in Paragraphs 2.4.3 through 2.4.5
in the context of private retirement funds.
In our view, acting in the “sole interest”

would require a trustee to consider
instrumental IFSI strategies to address
the material sustainability risks andopportunities that may affect the financial
interests of its beneficiaries. The California
Constitution mandates that trustees of its
pension funds “shall discharge their duties
with respect to the system solely in theinterest of, and for the exclusive purposesof providing benefits to, participants andtheir beneficiaries, minimizing employer
contributions thereto, and defraying
reasonable expenses of administering
the system. A retirement board’s duty toits participants and their beneficiaries
shall take precedence over any otherduty.”15 Likewise, New York law provides
that the trustee of a fund has the power
to make investments that “shall be forthe exclusive benefit of the participants
and beneficiaries.”16 Such state laws arein general silent on whether the terms“participant” and “beneficiary” should beinterpreted to include future participants
and beneficiaries, and in the absence of
language expressly contemplating such
future participants or beneficiaries, it
is likely, based on general principles of
judicial interpretation (which generally
require courts to apply the ordinary
meaning of words utilized and limit theirability to construe silence as permitting
an unarticulated objective), that suchterms would be construed as referring
to existing participants or beneficiaries
only. Existing participants may havea financial interest in the long-term
success that allows multi-generationaltransfer of wealth to children at the end

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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of a participant’s life, considering later
generations a beneficiary of their prudent
investments that reduce systemic risks totheir overall portfolio.
2.3.3

2.3.4

517

As noted in Paragraph 1.13 above,
under the “sole interest rule” of trust
fiduciary law, a trustee must consider
only the interests of the beneficiaries.
Accordingly, where a trustee is influenced
by sustainability factors in the way it
manages the fund, if motivated by thetrustee’s own sense of ethics or propriety(or the trustee’s own sense of thecollective will of its beneficiaries) or to
obtain collateral benefits for third parties,
it has violated the duty of loyalty. Under
the sole interest rule, a trustee violates
the duty of loyalty if the trustee has any
motive or rationale for undertaking anaction other than the “sole interest” or“exclusive benefit” of the beneficiary. A
trustee who is influenced by the trustee’s
own or a third party’s interests is disloyal,because the trustee is no longer acting
solely in the interest of the beneficiaries.
The sole interest rule imposes a
categorical prohibition, with “no further
inquiry” into whether a conflictedtransaction was fair. It has historically
been applied in a context in which a
conflicted transaction is unlikely to bebeneficial and beneficiary monitoring of
the trustee is weak.
When assessing whether a trustee
has acted in the “sole interest” of its
beneficiaries, federal and state courts
will also consider whether the trustee
has satisfied the “prudent investor rule,”
another fiduciary duty described below.

Prudent investor rule
2.3.5

2.3.6

A trustee is subject to a duty of care,referred to in trust law as a duty ofprudence, which requires the trustee toadminister the trust as “a prudent person
would, in light of the purposes, terms,
and other circumstances of the trust.”17
The principles of this duty, also known
as the “prudent investor rule,” wereincorporated in the Uniform Prudent
Investor Act (1992) (“UPIA”), which waspromulgated by the National Conferenceof Commissioners on Uniform State
Laws in 1994. Most states have adopted
a version of the UPIA, but states are
permitted to expand, restrict or eliminate
provisions of the UPIA when codifying
state law, including the prudent investor
rule. Further, the prudent investor rule
is a default that is subject to the actual
terms of the trust. Under the UPIA andmost of the state laws we have assessed,
the prudent investor rule requires atrustee to satisfy the fiduciary duty of careby investing and managing trust assets “asa prudent person would” and “exercis[ing]reasonable care, skill and caution.”18
As defined under the UPIA, the rule is afacts-and-circumstances standard that
requires a trustee to invest and manage
trust assets as a prudent investor would
by “considering the purposes, terms,
distribution requirements, and any othercircumstances of the trust.”19 A trustee
must employ “an overall investment
strategy having risk and return objectives
reasonably suited to the trust” and must
“diversify the investments of the trust.”20

2.3.7

In our view, this would require a trustee
to consider whether there are any
factors that create material risks oropportunities in seeking to achieve thefinancial investment objective of thetrust, including those that could arise asa result of sustainability factors. If so, thetrustee would also be required to consider
properly what steps, if any, to take. Where
adopting an IFSI approach can reasonably
be expected to help (either individuallyor collectively when taken together withthe actions of other parties) in mitigating
the risk or realizing the opportunity,
then the trustee should include that inits assessment and act accordingly. Any
assessment would need to take accountof all relevant circumstances including,for example, the need for impartiality(with appropriate consideration ofshort-term versus long-term benefits)
as between different generations ofbeneficiaries (see Paragraph 2.3.8, below),
the possible expense for the trust of theaction (whether in terms of investment
performance, costs or otherwise), themagnitude of the risk and its likelihood
and the period within which it could
crystalize. Given the litigious nature of
the United States, fiduciaries may face
investor challenges with respect to any
judgment exercised in the course of suchan assessment (including challenges as
to whether any action should have beentaken at all) if investors believe that any
actions taken by the trustee on the basisof any such assessment did not serve toenhance or protect investment returns.
Accordingly, as noted at Paragraph 1.10

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
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above as a practical matter, these factors
may lead trustees to focus particularly on
stewardship and public policy engagement
as a means of pursuing Sustainability
Impact goals.

Revenue Code of 1986 and certain federalbankruptcy laws. ERISA sets minimum
standards for most voluntarily establishedretirement plans to protect participants.
Additional, more stringent, standards
for private retirement plans can beestablished under state tax and labor law,
but the discussion below is limited to
ERISA.

Duty of impartiality
2.3.8

The “duty of impartiality” acknowledges
that a trustee must be loyal to all pension
plan participants and beneficiaries, andthat different groups covered by theplan may have different interests.21 The
duty requires that a trustee impartiallyconsider these potentially differinginterests, which can, for instance, include
the time horizon to retirement of different
participants and beneficiaries, but does
not require that a trustee ensure absoluteequality among competing interests.22 The
duty of impartiality has been incorporated
in the state laws of at least 15 different
states,23 but even absent express state law
on this point, it is likely that state courts
will refer to general principles of trust law
when interpreting the duties of a trustee
of a pension fund.

2.4.1

Overview of investment duties and powers – private
retirement plans
2.4

518

Private pensions and retirement plans aregoverned by the Employee Retirement
Income Security Act of 1974 (“ERISA”)
and certain amendments thereto.
Although ERISA is the primary federal
law establishing the legal duties andlegal powers of investment for private
retirement plans, other federal laws
may also apply to private retirement
plans, depending on the circumstances,including the United States Internal

2.4.2

ERISA requires retirement plans to provide
participants with plan information, setsfiduciary responsibilities for those who
manage and control plan assets and gives
participants the right to sue for benefits
and breaches of fiduciary duty.24 Under
ERISA, or “the regulation”, the exclusive
purpose of the ERISA fiduciary is toprovide benefits to participants and theirbeneficiaries and to defray reasonable
expenses of administering the plan.25
An ERISA fiduciary is liable for a breachof fiduciary responsibility if he or she(i) either participates knowingly in, or
knowingly undertakes to conceal, an act
or omission of another fiduciary, knowingthat such act or omission is a breach; (ii)fails to comply with the fiduciary duties
under ERISA in administering specificresponsibilities which give rise to status asa fiduciary, and enables another fiduciary
to commit a breach; or (iii) knows ofa breach of duty by another fiduciary,
unless there are reasonable efforts toremedy the breach.26
ERISA imposes a trust structure on mostprivate pension funds and retirement
plans to protect the interests of plan
participants.27 Accordingly, the U.S.
courts commonly treat the Restatementof Trusts as authoritative on issues under
ERISA relating to the obligations of those
who administer such funds and plans toparticipants and beneficiaries therein.28
The Restatement is an influential treatise
published by the American Law Institutefor practitioners of law, trustees andinvestment advisers. Although it is asecondary authority and thus non-binding,the Restatement is widely accepted as apersuasive source of law and is relied onby courts throughout the United States.
Responsibility for the interpretation andenforcement of ERISA is divided among
the Department of Labor, the Departmentof the Treasury and the Pension Benefit
Guaranty Corporation. As a practicalmatter, interpretative guidance issued byany of the foregoing is effectively viewed
as binding by industry participants,
although courts bear the ultimate
responsibility for interpreting ERISA
and whether regulations promulgatedthereunder are ultra vires or not.
Sole interest rule
2.4.3

Similar to the “sole interest” state law
rules governing public pension funds
described in Paragraph 2.3.2, under ERISA,
a plan fiduciary must act “solely in theinterest of the plan participants andbeneficiaries for the exclusive purposeof: (i) providing benefits to participants
and their beneficiaries; and (ii) defraying
reasonable expenses of administering theplan.”29 Under this rule, also sometimes
called “the sole benefit” or “exclusive
benefit” rule, the trustee “has a duty to
the beneficiaries not to be influenced
by the interest of any third person or

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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motives other than the accomplishmentof the purposes of the trust.”30 As such,a trustee would violate this duty if he or
she acted with any motive or rationale
for undertaking an action other than the“sole interest” of the beneficiary.
2.4.4

matters would use in the conduct of anenterprise of a like character and with like
aims.”32
2.4.6

In 2014, the U.S. Supreme Court held,in the context of the purpose to which
ERISA’s sole interest rule applies, thatthe benefits to be provided to plan
beneficiaries means “financial benefits.”
As interpreted by the U.S. Supreme Court,
the “exclusive purpose” of a trustee of afund governed by ERISA must be:‘providing benefits to participants and theirbeneficiaries’ while ‘defraying reasonable
expenses of administrating the plan.’ Read in thecontext of ERISA as a whole, the term ‘benefits’
in the [ERISA] provision just quoted must be
understood to refer to the sort of financial
benefits (such as retirement income) that trustees
who manage investments typically seek to secure
for their trust’s beneficiaries. . . . The term does
not cover nonpecuniary benefits[.]31

2.4.7

Prudent investor rule
2.4.5

519

A trustee’s conduct must satisfy thefiduciary duty of care, referred to as“prudence” in trust law. Similar to the“prudent investor rule” incorporated in
the UPIA governing public pensions, as
described at Paragraph 2.3.5, ERISA also
codifies the duty of care and requiresa private retirement plan trustee toact “with the care, skill, prudence, anddiligence under the circumstances thenprevailing that a prudent man acting in alike capacity and familiar with such

2.4.8

trustee is expected to balance the goals ofprotecting a trust’s principal and giving
a trust a reasonable rate of return. A
trustee’s duties also include a duty of full
disclosure of all facts that materially affecta beneficiary’s rights and interests.35 For
example, if a trustee reached the view thatdeclining systemic sustainability could
damage the level of benefits available toexisting long-term participants, it would
be under an obligation to disclose thatto them. Whether it feels obligated to do
so will depend on a comparison of the
expected timeframe within which existing
participants and beneficiaries will seek
to access their benefits under the trust
and the expected timing of the adverse
systemic impact on the level of benefits
available to them. Certain sustainability
factors could crystalize within a shortertime frame in a way that is hard to
predict and it would be expected for mostpension plans to include members withtime horizons for investing of 20–40
years. Finally, as noted above, as a matterof judicial interpretation, it will likely
be difficult for a trustee assessing theneed for such disclosure to conclude thatparticipants and beneficiaries shouldnecessarily include future participants andbeneficiaries without express statutory
support for such a conclusion.

Under the prudent investor rule asdefined by ERISA, a trustee must
employ a strategy that “diversif[ies] theinvestments of the plan so as to minimize
the risk of large losses, unless under thecircumstances it is clearly prudent not
to do so.”33 Such an approach does notpreclude a parallel strategy to address
systemic risks to the entire portfoliothat cannot be addressed by portfolio
diversification alone.
Factors a trustee needs to consider when
prudently exercising its powers include
the likely duration of the trust and theamount and timing of its distribution
requirements, along with potentiallyassociated needs for liquidity, stabilityof income flow and preservation of(or growth in) the purchasing powerof capital. The personal and financial
circumstances of the trust beneficiaries
inevitably impact decisions with respect tothe foregoing, insofar as they are relevantto the trust purposes.
A trustee’s duties under the “prudent
investor” rule not only apply to the initialinvestment decision, but also requirea trustee to continually observe andevaluate investments to ensure they are
consistent with the purpose and needsof a trust. In determining whether aninvestment is appropriate for a trust, atrustee should look at the investment’s
expected return, risks, marketability,
cost and any unique characteristics.34 A

Duty of impartiality
2.4.9

The Supreme Court confirmed in a 1996
decision that the common law duty of
impartiality, as described in Paragraph2.3.8, also applies to private retirement
plans under ERISA. In discussing various
duties of a fiduciary under ERISA, the

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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Supreme Court noted, “The common lawof trusts recognizes the need to preserve
assets to satisfy future, as well as present,
claims and requires a trustee to take
impartial account of the interests of all
beneficiaries.”36 Although the decisionrefers to future claims, because neither
ERISA nor the ruling expressly refers
to future beneficiaries, the reference
to beneficiaries is likely better viewed
as a reference to existing (not future)beneficiaries, some of whose interests areshort-term and others of whose interests
are long-term (and therefore may resultin future claims). Accordingly, the rulingwould appear to support the notion thatadverse Sustainability Impacts should
be taken into account when the relevant
adverse impact on the level of available
benefits is expected to occur within thetimeframe for receipt of benefits by
the youngest existing beneficiaries of
the trust, such as those climate change
impacts that may crystalize in a relatively
short period of years. As such, the dutyof impartiality clearly does not preclude
an instrumental IFSI strategy and, infact, would require the inclusion ofsustainability factors that impact theachievement of overall financial goals of
the fund. However, there is not yet similar
support for an ultimate ends IFSI strategy
that in our view would require still an
explicit guidance from the beneficiaries.
U.S. Department of Labor
2.4.10 The Department of Labor, or “DOL,”
regulates the investment practices ofprivate retirement plans. In recent years,
DOL issued a series of interpretive and520

field assistance bulletins to provide
guidance regarding ESG investing. We
consider such DOL guidance would
apply to IFSI on the basis that IFSI
involves investors intentionally taking
sustainability factors into account in
the way they manage their assets, either
in order to pursue financial return
goals or goals that go beyond financial
return. These DOL bulletins are designed
to provide guidance with respect toenforcement positions, clarification ofpolicies or changes in policy.37 Given
DOL’s responsibility for enforcement,
as a practical matter, these guidance
documents are viewed as binding byindustry participants who wish to avoid
the costs and potential penalties resulting
from any investigation.
2.4.11 An interpretive bulletin issued in 2015
(the “2015 Bulletin”) states that “ERISA
do[es] not permit fiduciaries to sacrifice
the economic interests of plan participantsin receiving their promised benefits inorder to promote collateral goals.”38 A
field advice bulletin issued in 2018 (the“2018 Bulletin”) reaffirms that “planfiduciaries are not permitted to sacrifice
investment return or take on additional
investment risk as a means of using plan
investments to promote collateral social
policy goals.”39 The key question arisingfrom both of these statements appears
to be whether ESG investing that is notentirely motivated by seeking to achieve
the financial investment objectives of theplan trustees (whether their approach
involves instrumental IFSI) will result in
the “sacrifice” of economic interests ofinvestment return and is therefore notauthorized. Both the 2015 Bulletin andthe 2018 Bulletin recognize that thisneed not necessarily be the case. DOL
has expressed the view that if a pension
trustee has two investment options
with otherwise identical risk and return
factors, the trustee may take collateralbenefits into account as a tiebreaker in its
decision on how to act. The 2015 Bulletin
states that “fiduciaries may consider
such collateral goals as tie-breakers whenchoosing between investment alternatives
that are otherwise equal with respect
to return and risk over the appropriate
time horizon. ERISA does not direct aninvestment choice in circumstanceswhere investment alternatives areequivalent, and the economic interests ofthe plan’s participants and beneficiaries
are protected if the selected investment
is in fact, economically equivalent tocompeting investments.”40 The 2018
Bulletin “reiterate[s] the view thatwhen competing investments serve theplan’s economic interests equally well,plan fiduciaries can use such collateralconsiderations as tie-breakers for aninvestment choice.”41 On the face of it,
this statement is difficult to reconcile withthe “sole interest” rule described above.
Furthermore, although there appears to besome evidence that the integration of ESG
considerations into investment decisions
may have only either a neutral or positiveeffect on the overall performance of aninvestment portfolio,42 it is by no means
the case that there is industry-wide
consensus on this point and it remains

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

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United Kingdom
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difficult to verify. In other words, where
pension trustees are pursuing collateralgoals, it may be challenging for them to be
confident that the situation is genuinely a“tie-break.” In this context, until pension
trustees are comfortable that they will not
expose themselves to potential litigation
for a breach of the “sole interests” rulein a tie-break situation, they may not be
comfortable relying on this statementin the 2018 Bulletin to make investment
selections that are intended to achievegoals that are collateral to the goal of
securing the requisite financial return(including ultimate ends IFSI).
2.4.12 That being said, with respect toinvestment-specific decisions relating toduties seeking to achieve the investment
objectives of the relevant plan, DOL
bulletins from 2015 and 2018 recognizethat ESG issues may influence thefinancial performance of investments
and accordingly investing with ESG
considerations can be consistent withERISA law when the trustee acts on“solely economic considerations.”43 As
with any other decision in relation to theplan, the trustee would need to follow aproper process in reaching its decision
as to whether or not to take into accountsuch ESG considerations. A trustee will
also likely want to ensure its ability toprove it indeed acted solely with economic
considerations in mind based on objective
criteria.
2.4.13 In October 2020, DOL finalized a rulethat adopts amendments to investment
duties under Title I of ERISA to confirm
that ERISA requires plan fiduciaries

521

to select investments and investment
courses of action based solely on financial
considerations related to the risk-adjusted
economic value of a particular investment
or course of action (the “2020 Final
Rule”).44 Under the 2020 Final Rule, DOL
notes that fiduciaries are prohibited from
subordinating interests of participants
and beneficiaries in their retirement
income to non-pecuniary goals, andfiduciaries were cautioned that accepting
reduced expected returns or greater risks
to secure non-pecuniary benefits is aviolation of ERISA.45 At the same time,
DOL continued to recognize what it refers
to as the “all things being equal” test, orthe “tie-breaker” standard, which allows
a fiduciary to make investment decisions
based on non-pecuniary factors if plan
fiduciaries cannot “distinguish alternative
investment options based on pecuniary
factors alone.”46
2.4.14 In March 2021, following the change tothe Biden administration, DOL announced
that it would not enforce the 2020 Final
Rule after hearing from a wide variety
of stakeholders that the rule had caused
investor confusion and had already had a“chilling effect on appropriate integrationof ESG factors in investment decisions,”
including in circumstances whereconsideration of ESG factors would bepermissible.47 DOL has been instructed byPresident Biden to revisit the 2020 Final
Rule, which became effective on January
12, 2021 but has not been enforced under
the new administration.48 The move isin line with the Biden administration’s
renewed prioritization of climate and

ESG issues, and may suggest that DOL
intends to take a more permissive
approach to ERISA rules that relate to theconsideration of ESG factors by fiduciaries.
Legal requirements to use investment powers to IFSI
– public pension funds
2.4.15 There is no legal requirement that
expressly requires a public pension
fund trustee to IFSI. There are, however,certain statutory regimes, such as U.S.
sanctions laws and rules against moneylaundering, the goals of which can beviewed as consistent with investing for
Sustainability Impact insofar as notinvesting in the relevant prohibited
investments may indirectly have positive
Sustainability Impact consequences,for example by reducing or preventing
the risk of corruption or other criminal
activity.
2.4.16 As mentioned above, in most if not
all states,49 the trustee has a duty toinvest solely for the financial interest of
beneficiaries. The term “beneficiaries”
is likely to be interpreted to refer only
to existing beneficiaries. However,these existing beneficiaries may include
beneficiaries with a longer time horizon
insofar as they will only be entitled tomake claims on the fund significantly inthe future when the impact of long-term
environmental and social sustainability
risk on economic returns may be morematerial and apparent. At least one state
court has recognized that a public pension
fund does not breach its fiduciary duty
by administering the fund to “create
and maintain long-term stability and

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B. THE EXTENT TO WHICH
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European Union
FranceJapan

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United Kingdom
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viability.”50 In our view, therefore, if
a trustee concludes (or ought to haveconcluded) both that (a) sustainability
factors pose a material risk to its ability
to achieve the economic objectives of its
overall investment strategy (or create
economic opportunities) and (b) it is ina position to take actions that (either
individually or collectively when taken
together with the actions of other parties)
can help to mitigate that risk or realize
the economic opportunities, then afailure to even consider, let alone act on,
the potential adverse financial impact ofsustainability factors on its investment
objectives (or potential economic
opportunities) and what it may be able to
do about them would appear to represent
a breach of its duties to investors. The
question then becomes what actions it
ought to take. As described at Paragraph2.3.7, where adopting an IFSI approach
can reasonably be expected to help (either
individually or collectively when taken
together with the actions of other parties)
in mitigating the risk or realizing the
economic opportunity, then the trustee
should include that in its assessment andact accordingly. Any assessment would
need to take account of all relevant
circumstances, including, for example,
the need for impartiality as between
different generations of beneficiaries,
the possible expense for the trust of theaction (whether in terms of investment
performance, costs or otherwise), themagnitude of the risk and its likelihood
and the period within which it could
crystalize. Among other things, the need522

for impartiality as described in Paragraph2.4.9 will require the trustee to balance
the risks to longer term beneficiaries
against the possibility of lower shorterterm returns for beneficiaries who are
already making claims or will be making
claims in the near future. Furthermore,particularly in public markets, there may
be a question as to the extent to which
the individual use of investment powers
by an investor is likely to have any impact
on the behavior of the relevant company(whether in terms of its sustainability
impact or otherwise), even if the trustee
is comfortable that the immediate
consequence of doing so will not be lower
investment returns that adversely affectimpartiality between beneficiaries. In thiscontext, although some commentators
have argued that specific investment
decisions ought to be made with such
longer term considerations in mind,51 it
may be easier for a trustee to reconcile
these competing beneficiary interests byinstead seeking to address the systemicrisks presented by sustainability factors
by engaging in collective sustainabilityrelated stewardship activities. However,
it is possible that the use of (or clear
willingness to use) investment powers
in this context to reduce or increase
company holdings could provide a way ofstrengthening voice.
2.4.17 As the potential adverse impacts ofclimate change and other sustainability
factors on investment returns (long-term
but also materializing in the short-term)
becomes increasingly apparent andsupported by peer-reviewed evidence, it isreasonable to expect instrumental IFSI tobecome more common, given:(a) the fact that the prudent investor rule
requires the trustee to take into accountthe duration of the trust, so that theamount and timing of its distribution
requirements may make it more likelythat a trustee would conclude that
long-term environmental and social
sustainability risk represents a sufficiently
imminent risk to future investment
returns;52(b) the fact that the prudent investor rule
expressly contemplates the revisiting ofprior investment decisions and requires
a trustee to continually observe andevaluate investments (as described in
Paragraph 2.4.8) so that a trustee shouldchange its existing strategy to adapt to
new circumstances and evidence; and(c) the requirement that a trustee disclose all
facts that materially affect a beneficiary’s
rights and interests will lead a trustee todisclose sustainability risks that could
result in material damage to the financial
position of the trust, potentially putting
it under pressure to adopt investment
strategies that can reasonably be expected
to help mitigate the risks disclosed.
Legal requirements to use investment powers to IFSI
– private retirement plans
2.4.18 There is no legal requirement that
expressly requires private retirement
plans to IFSI. As for public pension funds,
there are, however, certain statutory
regimes, such as U.S. sanctions laws andrules against money-laundering, that canbe viewed as consistent with IFSI insofar

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

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United Kingdom
United States

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as the investments that they preclude may
indirectly have a positive social impact,
for example by mitigating the risk ofcorruption or other criminal activity.
2.4.19 The circumstances in which the trustees
of a private retirement plan would need toconsider engaging in instrumental IFSI in
the way they use their investment powers
are similar to those described in relation
to public pension funds at Paragraphs
2.4.15 and 2.4.16 above. In that context, as
noted in Paragraph 2.4.9, the common law
duty of impartiality has been recognizedby the Supreme Court as applicable toprivate retirement plans under ERISA.
2.4.20 Note DOL’s guidance that investment
returns cannot be sacrificed when taking
ESG factors into account (see Paragraphs
2.4.10 through 2.4.14 above) does notprohibit instrumental IFSI since the aim ofthat is to help in generating the requisite
investment returns (or preserving longterm investment value in a mannerconsistent with that).
2.4.21 However, the extent to which trustees feel
confident about engaging in instrumental
IFSI in practice may depend on whether
DOL revises its existing rules, as discussed
in Paragraph 2.4.14, to no longer presume
that the inclusion of ESG factors ininvestment decisions requires a higher
burden to prove that these are relevant toachieving the requisite investment return(in other words, eliminating any guidance
that could be interpreted as requiring that
pursuing instrumental IFSI would require
greater evidence that investment returns
have not been sacrificed).

523

Legal freedom to use investment powers to IFSI –public pension funds
2.4.22 As described at Paragraph 2.4.16, decisions
on whether or not a public pension fundshould engage in IFSI will be determinedby an assessment of the impact ofsustainability factors on achieving
its financial return objectives. Suchassessment cannot be carried out basedon a traditional economic cost benefit
analysis, particularly when engaging in
IFSI to address systemic risks, becausesuch risks and the benefits of mitigatingthem are difficult to quantify. Decisions
will need to rely, at least in part, on
an assessment of the potential adverse
impact of ESG factors on portfolio value
and performance. In the event of a dispute
positing a causal link between engaging
in instrumental IFSI and an adverse
impact on financial return, a court would
seek to determine whether a proper due
diligence process was conducted by thefund manager that enabled it to makea reasoned determination in a mannerconsistent with its fiduciary duties, rather
than the ultimate outcome.
2.4.23 Some states, such as Delaware, that havenot adopted the UPIA have amended
their trust code in a way that mightallow for some element of IFSI, including
ultimate ends IFSI. For example, a 2018
amendment to the Delaware trust codeprovides that, “when considering theneeds of the beneficiaries, the fiduciary
may take into account the financial
needs of the beneficiaries as well as thebeneficiaries’ personal values, including
the beneficiaries’ desire to engage insustainable investing strategies thatalign with the beneficiaries’ social,environmental, governance or othervalues or beliefs of the beneficiaries.”53
As amended, the new Delaware trustcode makes enforceable a term of a trustthat prescribes a “sustainable or socially
responsible investment strateg[y] . . .
with or without regard to investment
performance.”54 In states that adopted
the UPIA, as described above at Paragraph2.3.5, the prudent investor rule is a
default rule, which may be expanded,
restricted or eliminated or otherwise
altered by the express provisions of atrust.55 It is possible, therefore, that somestates could adopt provisions similar to
those adopted by Delaware. Where a statepermits (but does not mandate) taking
into account “sustainable or socially
responsible” strategies (i.e., so that they
are permitted to engage in instrumental
IFSI), the fiduciaries of such pension plans
would need to obtain the requisite supportof the beneficiaries to alter the provisionsof the trust documentation in accordancewith any applicable voting requirementsof their constitutive documentation A
strategy that relies on provisions suchas that found in the Delaware trust code
does not conflict with the “sole interests”
rule that requires a trustee to administer
the trust in the “sole interest” of its
beneficiaries.56 In other words, unless therelevant state trust code provisions clearlysupersede the “sole interests” rule, itwould appear that trustees will be limited
to instrumental IFSI in the theoretical“tie-break” situations such as thosedescribed in Paragraph 2.4.11.57

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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Legal freedom to use investment powers to IFSI –private retirement plans
2.4.24 The position is broadly similar tothat described above in relation to
public pension funds. See Paragraphs
2.4.10–2.4.14 for a discussion of DOL’s
interpretive and field assistance bulletins
guidance and 2020 Final Rule regarding
ESG integration. As noted, the guidancestates that private pension funds should
not take ESG factors into account in theiruse of investment powers unless the
ERISA fiduciary can conclude that doing
so will have a positive (or, in a tie-breakersituation, neutral) impact on investment
returns.
2.5

Mutual funds
Asset Owner: The fund. Mutual funds
have a two-tier decision-making structure.
Mutual funds are governed by a boardof directors, which, in turn, generally
hires an Investment Adviser to makeinvestment decisions and conduct theday-to-day operations of the fund. The
Investment Adviser’s employees may
also be investors in or directors of thefund. The board of directors oversees theInvestment Adviser and represents theinterests of the fund’s shareholders.58
Beneficiaries: Individual investors.
Investment decision-maker: Investment
Adviser. The typical relationshipbetween an Investment Adviser andan Asset Owner that is a fund is aprincipal-agent relationship, where
the principal (the Asset Owner) hires
an agent (the Investment Adviser) toperform investment advisory services524

on the principal’s behalf. Investors andinvestment advisers, to some extent, havedifferent interests in these arrangements.
For example, while both are likely to want
the mutual fund to achieve its financial
objectives, the Investment Advisor also has
an economic interest in generating fees.
Potential issues that could emerge fromthis element of intermediation include thepossibility that Investment Advisers couldalign with their own corporate positions
on issues, including sustainability-related
issues that are a focus of IFSI, and havedifferent time horizons given their typicalappointment for shorter time periods.59
Types of mutual funds covered
2.5.1

There are three main types of investmentcompanies in the U.S. (one of which, ETFs,
defined below, can be viewed as a hybridof the other two):(a) Open-end mutual funds are bodies
corporate the shares of which can beacquired and redeemed by investors
at any time, subject to very limited
circumstances in which redemptions
can be suspended. Thus, the numberof shares of an open-end fund is always
changing, and as the fund receives
additional investment, its portfolio grows.
An investor will generally purchaseshares in the fund directly from thefund itself, rather than from existing
shareholders. Most open-end funds areactively managed, although there has
been substantial growth in Assets Under
Management committed to index funds(including ETFs). The price at which sharesin an open-end fund are issued or can beredeemed will vary in proportion to the
net asset value of the fund and so directlyreflects its performance.60(b) Unit investment trusts (“UITs”) areexchange-traded mutual funds with afixed portfolio of stocks and/or bonds thatare created for a specific length of time.
A UIT is not actively managed and has noboard of directors. A UIT’s securities will
not be sold or new ones bought except
in certain limited situations (such as
bankruptcy or a merger).61(c) Exchange-traded funds (or “ETFs”)
are investment funds traded on
public exchanges whose price changes
throughout the day. Unlike open-end
mutual funds, ETFs do not sell individual
shares directly to, or redeem theirindividual shares directly from, retailinvestors. ETFs have traditionally been
designed to track the performance of
published indices or a pre-defined basket
of stocks, commodities and/or bonds
and are therefore generally not actively
managed even though they have an
Investment Adviser. Actively managed
ETFs that buy or sell investments
consistent with a stated investment
objective are also permitted by the
SEC. The popularity of ETFs has rapidly
increased in recent years because of their
low transaction and management costs
and stock-like features. An ETF operates
with an arbitrage mechanism designed
to keep it trading close to its Net Asset
Value (“NAV”) and therefore combines thevaluation feature of an open-end fund,which can be bought or sold at the end ofeach trading day for its net asset value,

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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UNITED STATESCONTENTSFOREWORDSINTRODUCTION

with the tradability feature of a closedend fund, which trades throughout thetrading day at prices that may be more orless than its net asset value. Closed-end
funds are not considered to be ETFs, eventhough they are funds and are traded on
an exchange, because ETFs have the ability
to redeem or issue new shares based oninvestor inflows and outflows and closedend funds (unlike most ETFs) are generally
actively managed.62 A small number of
ETFs are structured as UITs.63

regulation by the SEC under the Securities
and Exchange Act of 1934 (as amended,
the “Exchange Act”).
2.5.4

Overview of investment duties and powers
2.5.2

2.5.3

525

Mutual funds are professionally managed
investment funds that pool money frommultiple investors to invest in securities
and, at times, higher-risk investments.
The fund’s portfolio is managed by an
Investment Adviser. Due to economies ofscale, they can achieve a higher level ofdiversification.
Mutual funds are principally regulated
under the Investment Company Act
of 1940 (as amended, the “Investment
Company Act”). The Investment Company
Act regulates the organization ofcompanies, including mutual funds, thatengage primarily in investing, reinvesting
and trading in securities, and whose own
securities are offered to the investing
public. Among other things, it is designed
to minimize conflicts of interest that arisein these complex operations. Under the
Securities Act of 1933 (as amended, the“Securities Act”), all mutual funds must
be registered with the SEC as investmentcompanies. Mutual fund issuers are
subject to reporting requirements and

2.5.5

2.5.6

Mutual fund Investment Advisers
are principally regulated under theInvestment Advisers Act of 1940 (asamended, the “Investment Advisers Act”).
The Investment Advisers Act requires
firms or sole practitioners that receive
compensation for securities investment
advice to register with the SEC and comply
with regulations promulgated under theAct. Generally, only large advisers, whohave at least $100 million in assets undermanagement, must register with theSEC. States may also require registration
under similar state-level legislation, andan Investment Adviser may be required toregister with multiple states, depending
on its operations and state requirements.64

mutual fund is exposed and information
regarding the fund’s fees and expenses(including shareholder fees and operating
expenses).65 As discussed further inParagraph 2.5.11 below, principal
investment risks would also include
material ESG factors.
2.5.7

Under the SEC’s regulations,66 mutual
funds are required to incorporate in their
public disclosures all material risks totheir investment strategy.

2.5.8

In addition to the requirements of federallaw, which apply to the mutual fundvehicle itself, the directors of a mutualfund owe duties to the fund, dischargeof which is potentially relevant to IFSI.
Directors of mutual funds must abideby standards of care prescribed by statestatutory and common law. Specifically,
directors are subject to state law duties
of care and loyalty. The duty of caregenerally requires that directors act
in good faith and with that degree of
diligence, care and skill that a personof ordinary prudence would exercise
under similar circumstances in a likeposition of responsibility with respect
to a mutual fund. The duty of loyalty
generally requires that directors exercise
their powers in the interests of the fundand not in the directors’ own interests
or in the interests of another person ororganization.

Registration with the SEC subjects
mutual funds to numerous regulatory
requirements imposed for the protectionof investors. Primary regulation occurs
under the Investment Company Act andthe rules adopted under that Act, butmutual funds are also subject to the
Securities Act and the Exchange Act,
which broadly regulate publicly tradedsecurities and require disclosure ofmaterial information to investors.
Mutual funds must provide interested
investors with a prospectus which, among
other things, is required to disclose
the investment objectives or goals of
the mutual fund, information on thefund’s past financial performance, theprincipal investment risks to which the

2.5.9

Under the law of most states, the legal
standard of review generally appliedby courts of competent jurisdiction
with respect to the duty of care and the
duty of loyalty owed to a company by

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

UNITED STATESCONTENTSFOREWORDSINTRODUCTION

its directors is the “business judgmentrule.” Some states have codified thebusiness judgment rule through so-called“constituency statutes,” which expressly
state that directors are empowered tobalance the interests of all stakeholders,
employees and other stakeholders.
However, Delaware, one of the mostimportant states in the United States forcorporate law (due, in part, to the numberof corporations that are organized there),
does not have a constituency statute,and directors must make decisions in
the best interests of the corporation andits shareholders. Under the businessjudgment rule, a court will uphold thedecisions of a director and not secondguess business judgments so long as
they are made in good faith, with thecare that a reasonably prudent person
would use and with the reasonable
belief that the director is acting in thebest interests of the corporation. Under
the best interest rule, an action by afiduciary that is in the self-interest of thefiduciary will be in the best interests ofthe beneficiaries with sufficient frequency
that the beneficiaries are better off withan inquiry into whether a transaction
passes an “entire fairness” test. This isespecially likely if the fiduciary (e.g., acorporate board of directors) was chosen
for professional expertise that overlaps
with the fiduciary’s personal interests.
Transactions that do not satisfy theentire fairness test will likely come to theattention of investors and therefore be
subject to effective challenge.

526

Legal requirements to use investment powers to IFSI
2.5.10 We are not aware of any provision that
expressly requires mutual funds touse investment powers to pursue an
instrumental IFSI strategy, unless themutual fund has been established with aninvestment objective in its prospectus thatessentially requires it to engage in suchan IFSI strategy, so that investors acquire
fund interests with the expectation thatsuch objective will be pursued. Under §8(b)(3) of the Investment Company Act,a mutual fund’s registration statement
must include all “matters of fundamental
investment policy,” and the accuracy ofthat statement and the fund’s prospectus
are subject to anti-fraud rules under Rule10b-5 of the Exchange Act and §§ 11 and
12(a)(2) of the Securities Act. Therefore,
if a fund discloses in its prospectus that
it will engage in an investment approachwithin the scope of IFSI, under federal
securities law, it has a duty to do so andwill be subject to enforcement action
from the SEC if the SEC determines thatthe fund made inaccurate or fraudulent
representations in the fund’s registration
statement. However, there is no general
duty to invest a fund’s portfolio in a waythat secures the well-being (defined more
broadly than purely in financial terms) ofbeneficiaries, reflects the sustainability
aspirations of the beneficiaries or seeks tofurther wider societal goals unless suchobjectives are already disclosed in thefund’s prospectus. In theory, the pursuitof instrumental IFSI may be needed tosecure the financial objective of the fund.
However, because registration statements
must be tightly drafted to include all“matters of fundamental investment
policy”, there is usually not sufficient
latitude to use investment powers to
pursue an instrumental IFSI strategy
unless explicitly provided. As discussed
below in Paragraph 3.3, there is more
latitude to use stewardship activities
around instrumental IFSI that may affectfund performance.
2.5.11 As discussed in Paragraphs 2.5.6 and 2.5.7,
mutual funds are required to provide
investors with a prospectus that includes
a description of the principal investment
risks to which the mutual fund is
exposed, and mutual funds are required toincorporate in their public disclosures allmaterial risks to their investment strategy,
which accordingly requires the disclosureof relevant Sustainability Impact-relatedrisks to the extent that they are deemed tobe financially material, even if the fund’sinvestment objective does not specificallyrequire an investment approach within
the scope of IFSI.
2.5.12 Where a fund’s disclosed investment
objective specifically contemplates an
IFSI investment approach, there is a clear
requirement for the disclosure of metrics
with which investors may gauge theextent to which such objective is being
attained. The determination of materiality
will be made within the context of thepotential impact on the stated investment
objective and will require disclosure of thematerial risks to the achievement of suchobjective as well as the steps (if any) thatthe mutual fund is taking to address thoserisks.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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UNITED STATESCONTENTSFOREWORDSINTRODUCTION

2.5.13 For mutual funds that do not include
an IFSI objective, materiality, and thedisclosure of material risks, must be
viewed under more general standardsof what is material under relevant U.S.
federal laws. Information is material if
there is a substantial likelihood that areasonable investor would consider the
information important in deciding how
to vote or make an investment decision.
As more investors indicate that enhanced
Sustainability Impact-related disclosure
is a significant factor in their investment
decisions, there is a potentially increased
risk to the fund of there being a smaller
pool of new investors and outflows ofexisting investors that may result from a
failure to include such disclosure.
2.5.14 These risks have arguably reached apoint that they present a financiallymaterial risk to a fund and its strategy,
including its ability to diversify its
portfolio adequately. Decreased liquidityof the fund units may also adversely
impact investors. In this context, it may
therefore be reasonable for mutual funds
to conclude that enhanced Sustainability
Impact-related disclosure is material to areasonable investor’s investment decision.
If this conclusion is correct, then funds
that eschew such disclosure may, as analternative approach, need to include
a risk factor in the fund’s prospectus
disclosing that the failure to include
such disclosure may make the fund lessattractive as compared to other funds
and result in investor outflows and lower
liquidity.
2.5.15 For those mutual funds that decide527

to provide disclosure of Sustainability
Impact-related metrics because they
conclude that such information ismaterial to the investment decisions of
their investors, such metrics should beclearly defined and include an explanationof how each such metric is calculated
and why it provides useful information toinvestors.
2.5.16 When providing Sustainability Impactrelated metrics for the purpose ofallowing investors to assess IFSI, as withthe disclosure of financial and operating
metrics, the metrics must provide a fulland fair representation of the informationthat is purported to be conveyed, without
the selective disclosure of metrics
intended solely to show the fund in abetter light.
2.5.17 The selection of a particular fund namethat could be interpreted as implying
an IFSI objective may also be relevant to
the exercise of investment discretion,with the effect that it could be necessary
for a mutual fund to adopt an IFSI
investment approach in order to act ina manner consistent with the way thefund has been marketed to investors. In
March 2020, the SEC published a request
for comment on the framework forevaluating requirements for registeredinvestment companies’ names. §35(d) of
the Investment Company Act prohibitsa registered investment company (which
includes mutual funds, closed-end funds,
UITs and ETFs) from adopting a name that
includes words the SEC deems materiallydeceptive or misleading (known as the“Names Rule”). For registered investmentcompanies with a name that suggests a
particular type of investment, the Names
Rule requires the fund to adopt a policy
to invest at least 80% of its assets in thetype of investment, industry, country,
geographic region or tax exemption
suggested by its name. The SEC Staff
solicited input on whether the Names
Rule should apply specific requirements
for ESG or sustainable registered funds
and what those requirements should be,
if any. The SEC Staff also asked market
participants whether registered funds
should be limited in characterizing
investments as sustainable or ESG andwhether a registered fund with ESG in
its name must make investments thatmeet certain ESG factors or criteria. In a
July 2021 speech, SEC Chair Gary Gensler
stated: “When it comes to sustainabilityrelated investing, though, there’s
currently a huge range of what asset
managers might mean by certain terms orwhat criteria they use.”67 The question ofwhat kind of disclosures are required for
purported ESG funds will continue to beat the forefront of SEC regulation in thisarea.68
2.5.18 Further limiting the potential thatmutual funds would be required to use
investment powers to pursue instrumental
IFSI, we are not aware of any general dutyor requirement to manage a fund in a waythat takes into account the prospect that
potential future fund investors may be
more materially and adversely impacted
by sustainability factors, since prioritizingthese potential investors would beinconsistent with the entire fairness test

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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UNITED STATESCONTENTSFOREWORDSINTRODUCTION

described above. That said, many mutual
funds are likely to have investors witha range of time-horizons, some longterm and, when it comes to any needto take account of sustainability factors
in managing the assets of a fund, evengiven the open-ended structure of funds
to facilitate ease of investor entry andexit, it will be necessary to bear in mind
the potential for some sustainability andassociated transition risks to crystallize inthe short-term.

criteria alongside other factors, suchas macroeconomic trends or companyspecific factors like a price-to-earnings
ratio, to seek to enhance performanceand manage investment risks. Other
funds focus on ESG practices because they
believe investments with desired ESG
profiles or attributes may achieve higher
investment returns and/or encourage
ESG-related outcomes.”70 However,absent legislation expressly permitting
such a change without investor consent,
it would be difficult for an existing
fund to change its previously disclosed
investment objective altogether to one
that required it to use its investment
powers to engage in instrumental or
ultimate ends IFSI without majority, if
not unanimous, investor consent (giventhat its existing investor base will havemade their determination to invest basedon disclosure of the fund’s investment
objectives prior to the relevant change),
unless it is able to conclude that suchengagement represents the natural
evolution and continuation of suchpreviously disclosed objective.

Legal freedom to use investment powers to IFSI
2.5.19 Mutual funds are free to organize
themselves as a fund with an objectivethat would involve engaging in an
investment approach within the scope of
IFSI so long as such investment objective
is properly disclosed in the fund’s
prospectus, along with the potential risks
to investors (including, if relevant, thepotential risk of lower financial returns ascompared to benchmark funds that do nothave an equivalent objective but invest in
similar securities).
2.5.20 Separately, mutual funds may amend
their prospectuses to disclose explicitly toinvestors that a fund’s strategy to achieve
its existing investment objectives includes
considering ESG-related factors in its
investments. In 2019, nearly 500 funds did
so.69 On February 26, 2021, the SEC issued
a bulletin to investors that explained,“Funds that elect to focus on companies’
ESG practices may have broad discretionin how they apply ESG Factors to theirinvestment and governance processes.
For example, some funds integrate ESG

528

2.6

Insurance undertakings
Asset Owner: The insurance company isthe asset owner and invests the premiums
that are paid to it by its policyholders.
Beneficiaries: The insurance company’s
policyholders and shareholders are
the beneficiaries of the company’s
investments. Policyholders in the sensethat any payments made under policies
are financed from the investment of thecompany’s assets. Shareholders in thesense that they benefit from the insurancecompany’s dividends and capital growth.

ACKNOWLEDGEMENTS

Investment decision maker: Insurancecompanies may use internal or external
Investment Advisers. The largest
insurance companies have sufficienteconomies of scale to support their own
internal Investment Adviser, whether partof the insurance company, a subsidiary orother affiliate. However, many insurancecompanies outsource all or part of theirasset management to external Investment
Advisers. Many of the largest external
insurance company Investment Advisers
are also mutual fund Investment Advisers.

EXECUTIVE SUMMARY

Types of insurance undertaking covered
2.6.1

In the U.S., insurance companies are
regulated by the laws of each state, andso there is not one uniform law that
regulates and sets standards for insurancecompanies.

(a) Life insurance: The insurer undertakes,
in consideration of a specific premium
being paid, to pay out a lump sum or
fixed regular income on death or anotherdefined event. There are three roles
involved in the policy purchase: (i) the
policy owner; (ii) the insured person;and (iii) the beneficiary. With respect tolife insurance, a policy owner purchases
insurance that provides financial coverageover a person’s life, known as the insured.
The insured may or may not be the policy
owner. The beneficiary is the person (ormultiple people) who will receive death
benefits when the insured passes away.
Life insurance may be term insurance,
which covers a defined period of time.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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If the insured person survives the term,
there is no payout. Permanent life
insurance provides coverage for an entire
lifespan, and a payout occurs so long as
the premiums on the policy continue
to be paid. There are two main typesof permanent life insurance: whole life
insurance; and universal life insurance.
Whole life insurance has a fixed coverageand premium amount and has thepotential to accumulate cash value overtime. Universal life insurance offers
flexible premiums and the cash valueearns interest at the greater of the current
market rate or the minimum interest rate
set by the policy.

with some exceptions, as described in
Paragraphs 2.6.8 through 2.6.10.
2.6.4

2.6.5

(b) General insurance includes insurance
policies that are not life insurance,
including property, accident andsickness, travel and liability insurance,
among others. The insurer’s liability is
to pay out when a valid claim is made by
the relevant policyholder. Any profits ofinvestment activity are retained by the
insurer.
2.6.2

Insurers may have a range of objectives
for their asset portfolio. Investments madeby insurance companies in relation to
products with a longer-term time horizon,such as life insurance, focus on long-termyield, while others focus on total return.

Overview of investment duties and powers
2.6.3

529

Under the McCarran-Ferguson Act of1945, insurance companies are exempt
from most federal regulation. They
are therefore organized and regulated
primarily on a state-by-state basis,

2.6.6

It is necessary to distinguish between thelaw as it applies to the insurance company
and the law as it applies to the directorsof the insurer who determine whatbusiness it should undertake and on whatterms (and who would also, therefore, be
responsible for decisions about whether itshould engage in IFSI).

2.6.7

In the case of the former, to the extent
that insurance companies are publicly
listed corporations, they must comply
with federal SEC obligations relating
to disclosures of material information
reasonably expected to affect the value ofthe corporation. In addition to the duties
that apply under legislation, insurancecompanies also have contractual
obligations to policyholders under theterms of their policies. If and to the extent
that policies contain undertakings by
the insurance company as to how it will
manage the insurance funds collected inorder to generate returns sufficient to
pay entitlements under such policies, theinsurance company must comply withsuch provisions. Such provisions could
include a requirement to engage in IFSI.
In the case of the latter, under the
corporate law of most states, the directorsof the insurer owe a duty of care and a
duty of loyalty to the company. Under thelaw of most states, the legal standard ofreview for these duties is the “businessjudgment rule” (absent certain triggers
which may result in higher levels of
scrutiny, such as when a director has a

2.6.8

potential conflict of interest that could
result in a breach of the duty of loyalty).

ACKNOWLEDGEMENTS

As described earlier in this report inParagraph 2.5.9, under the businessjudgment rule, a court will upholdthe decisions of a director of a publiccompany and not second-guess businessjudgments so long as they are madein good faith, with the care that areasonably prudent person would use
and with the reasonable belief that thedirector is acting in the best interests ofthe corporation—that is, acting for the
benefit of the beneficiaries as a whole.
Under the best interest rule, an action by afiduciary that is in the self-interest of thefiduciary will be in the best interests ofthe beneficiaries with sufficient frequency
that the beneficiaries are better off withan inquiry into whether a transaction
passes an “entire fairness” test. This isespecially likely if the fiduciary (e.g., acorporate board of directors) was chosen
for professional expertise that overlaps
with the fiduciary’s personal interests.
Transactions that do not satisfy theentire fairness test will likely come to theattention of investors and therefore be
subject to effective challenge.

EXECUTIVE SUMMARY

In 2010, Congress passed the Dodd–
Frank Wall Street Reform and Consumer
Protection Act (the “Dodd–Frank Act”).71
Significantly, Title V of the Dodd–FrankAct created the Federal Insurance
Office (“FIO”) in the Department of
the Treasury.72 The FIO is authorized
to monitor the insurance industry
and identify any gaps in the state-

A. INVESTING FORSUSTAINABILITY IMPACT

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based regulatory system. The FIO’s
authority to report on and monitor the
insurance industry extends to all lines
of insurance, except health insurance,
certain long-term care insurance andcrop insurance.73 In particular, theDodd-Frank Act authorizes the FIO toconsult with state insurance regulators on“insurance matters of national importanceand prudential insurance matters ofinternational importance.”74 The FIO
also may assist the Treasury Department
in international negotiations of certain
bilateral or multilateral agreements
regarding prudential insurance mattersand determine whether those agreements
preempt state laws.75 Accordingly, somecommentators have argued that entry
into an international climate change
agreement that relates to prudential
insurance matters could offer the FIO
an opportunity to preempt the policy
positions of state insurance authorities
and the National Association of InsuranceCommissioners.76
2.6.9

530

The Dodd–Frank Act also established
the Financial Stability Oversight Council(“FSOC”).77 The FSOC is charged with
monitoring the financial services markets,
including the insurance industry, toidentify potential risks to the financial
stability of the United States.78 It may
determine that an insurance company or
insurance broker (if it is a “U.S. nonbank
financial company” for purposes of andas defined in the Dodd–Frank Act79) is
systemically significant and therefore
subject to prudential supervision by the

Board of Governors of the Federal Reserve
System (the “Federal Reserve”).80 The
FSOC may make recommendations to theFederal Reserve regarding, among otherthings, the establishment of increased
reporting and disclosure requirements andgeneral risk management for nonbank
financial companies that are supervised by
the Federal Reserve (“Supervised Nonbank
Financial Companies”).81
2.6.10 The FSOC is also empowered to makerecommendations to primary financial
regulatory agencies regarding theapplication of new or heightened
standards and safeguards for financial
activities or practices, and certain
participation in such activities, thatthreaten the stability of U.S. financial
markets. A primary financial regulatory
agency must impose standards
recommended by the FSOC, or standards
similar to those recommended, or must
explain in writing to the FSOC why theagency has determined not to follow therecommendations.
2.6.11 Under the state-based insurance
regulation system, each state operates
independently to regulate its own
insurance markets, typically through astate department of insurance or divisionof insurance. The National Association of
Insurance Commissioners (“NAIC”) is astandard-setting and regulatory support
organization created and governed by
the chief-insurance regulators from the
50 states, Washington D.C. and five U.S.
territories.82

2.6.12 Each state decides whether to pass each
NAIC model law or regulation, and eachstate may make changes in the enactment
process, but the models are widely, albeit
somewhat irregularly, adopted.
2.6.13 While laws vary from state to state,
generally, investment options for
insurance companies are highly controlled
and limited by state regulations, which
are designed to ensure that insurers will
have appropriate reserves and liquidity
to satisfy claims from their insured
policyholders. As NAIC described in 2012,“Because investment is a large part of theinsurance business, regulators pay close
attention to investment risk, encouraging
less risky investment when appropriate. In
the 1990s, insolvencies caused by high-risk
investment strategies led U.S. regulators
to consider their oversight and possible
restriction of insurer investments . . . .”83
2.6.14 The outsourcing of an insurancecompany’s investment management does
not relieve the insurer’s management andits board from investment responsibilities,
and oversight of external Investment
Advisers will be required to ensure thatthe portfolio is managed appropriately.
General insurance: Legal requirements to use investment
powers to IFSI
2.6.15 We are not aware of any provision that
expressly requires insurers to use theirinvestment powers to pursue instrumental
IFSI. However, insurers are obligatedto manage their assets with care, skill,
prudence and diligence because, as withmutual funds, directors of insurers
must abide by the director’s duty of

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FranceJapan

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care and duty of loyalty, as described in
Paragraphs 2.5.8–2.5.9. Because insurancecompanies need to ensure that they havesufficient funds (and the appropriate
level of liquidity) to satisfy claims, they
will need to manage their assets in a waythat would enable them to pay claims
under the policies they have written,
including future claims that may arise asa result of sustainability risks. Given thisobjective, the duty of care and duty ofloyalty arguably requires a director of an
insurance company to consider long-termsustainability risks (including the sort that
instrumental IFSI might seek to address)
and their potential adverse financial
impact on the company’s portfolio whenselecting investments if they conclude
that doing so is in the “best interests” of
the insurer. The size of a large insurancecompany’s assets under management may
result in pressure from both shareholders
and policyholders to apply such resources
to instrumental IFSI to achieve longterm growth of assets. Of course, allsuch transactions will need to satisfy theentire fairness test or risk coming to theattention of shareholders or policyholders
and becoming the subject of challenge.
2.6.16 Unless it is contractually provided for in
the terms of the relevant policy (in thecase of policyholders) or required by its
constitutive documents or applicablestate corporations law (in the case ofshareholders), we are not aware of
any requirement for directors of an
insurance company to assess the viewsof policyholders or shareholders on IFSI
or any other preference. The views of531

shareholders are nevertheless likely to
be important to directors, particularly ifthey are held by a block of shareholders
with sufficient votes to remove directors.
However, regardless of the views ofshareholders, directors remain bound toact in the “best interests” of the insurerand ensure that transactions pass the“entire fairness” test.
2.6.17 General risk reporting and disclosure
requirements under applicable securities
laws that are not IFSI-specific will dictate
whether or not any disclosure of thepotential negative impact of a failure to
IFSI on the performance of an insurer’s
investments is necessary. If an insurancecompany identifies and discloses
sustainability risks that may adversely
impact its financial performance, its
directors will be obligated under the
duty of care to consider what steps, ifany, ought to be taken by the company
to avoid or mitigate such risks. Where
approaches consistent with instrumental
IFSI could provide an effective way ofaddressing these risks to financial returnand preservation of assets, directors
would need to consider them and, if they
conclude that such an approach willin fact serve to address such risks, act
accordingly.
General insurance: Legal freedom to use investment
powers to IFSI
2.6.18 We are not aware of any law prohibiting
insurers from pursuing instrumental IFSI
as part of their objectives and strategy for
managing portfolio assets. Insurers havethe flexibility to pursue instrumental

IFSI, so long as they invest in a way that(a) maintains sufficient reserves andliquidity to cover claims, (b) falls within
the constraints of the business judgment
rule and applicable state laws pertaining
to permissible investment strategies and(c) does not conflict with the terms of anyof their policies.84
2.6.19 As public companies, the directors of
insurance companies are held accountable
to their shareholders, and so it may bedifficult to ignore investor demands thatthey exercise their powers to invest in
ways that would fall within the scopeof instrumental IFSI. 85 However, as
noted above, this shareholder pressurecannot trump the directors’ duty to act
in the “best interests” of the company
and engage in transactions that pass
the “entire fairness” test. In order toreconcile the two, the directors will needto conclude that the failure to do so may
adversely affect the financial performanceof the company.
Life insurance: Legal requirements to use investment
powers to IFSI
2.6.20 Analysis of the legal requirements to use
investment powers to pursue instrumental
IFSI in the context of life insurance issimilar to that of general insurance(Paragraphs 2.6.15–2.6.19).
2.6.21 In addition, if there is consumer demand
for life policies that involve the underlying
funds being invested in ways that would
fall within the scope of instrumental IFSI,
then it is legally permissible for a life
insurance company to enter into policiesof that sort. Having done so, similar to a

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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mutual fund with an explicit instrumental
IFSI investment objective as describedin Paragraph 2.5.10, the life insurancecompany would then be required topursue the relevant investment approach
and, in the event of a delegation of
investment management, to require thatits Investment Adviser does the same.
Life insurance: Legal freedom to use investment powers
to IFSI2.6.22 The legal freedom to use investment
powers to instrumental IFSI in thecontext of life insurance is similar tothat of general insurance (Paragraphs
2.6.18–2.6.19), although it is more likelythat a life policy could stipulate an
investment objective or policy if the policyin question is more akin to an investment
product than a protection product suchas whole life insurance, the value of
which (as determined based on a portfolio
of investments for which a particularinvestment strategy could be stipulated)can be borrowed against in a tax-efficientmanner as part of the policyholder’sretirement strategy. If this is the case, theterms of the life policy may constrain, or
explicitly promote, investment in pursuitof sustainability impacts that would fallwithin the scope of instrumental IFSI.

2.6.23 To the extent that the terms andconditions of the relevant product aresilent on the issue of Sustainability
Impact, a pursuit of instrumental IFSI
should be possible taking into accountrisk-return objectives, which will likely
include different time horizons dependingon the product objectives. However,similar to the discussion on pension funds
in Paragraph 2.4.22, due to the litigious
environment in the U.S., the directorsof an insurer will need to conclude that
pursuing an instrumental IFSI strategy
will not be likely to lead to lower financial
returns unless it is marketed andapproved by users as such.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

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BrazilCanadaChina

European Union
FranceJapan

Netherlands

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United Kingdom
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3.

ASSET OWNERS’ USE OF THEIR POSITION TO ENGAGE IN STEWARDSHIP ACTIVITIES TO SECURESUSTAINABILITY IMPACT

3.1

The following section considers the extent
to which, and on what basis, each typeof Asset Owner is (a) legally required or(b) legally permitted or able to use its
position to influence enterprises in which
it invests by engaging in stewardship
activities designed to achieve positive
sustainability impacts and minimize
negative sustainability outcomes.

Impacts in order to discharge its duties
in relation to realizing a financial return(directly or through stewardship, or the
stewardship policies they set for their
Investment Advisers), than throughinvestment or divestment. Among otherthings, stewardship may have less directconsequences for short term financial
performance measured against relevantbenchmarks.

Overarching considerations
3.1.1

3.1.2

3.1.3

533

In general, when we refer to stewardship,
we refer to an Asset Owner’s attempt
to influence the behavior of companies
through direct engagement, forming
coalitions to campaign for change,
submitting items for a vote at company
annual meetings through the shareholder
proposal process under Rule 14a-8 of
the Exchange Act,86 developing andexercising voting guidelines that reflectsustainability activities and exercising
votes in favor of other shareholders’proposals regarding sustainability
initiatives, among others.
A large group of Asset Owners haveactively engaged in stewardship activities
to achieve positive sustainability impacts
with the express purpose of improving
long-term financial returns and thepreservation of value.87
In many cases, there may be more
flexibility for Asset Owners to pursue
instrumental IFSI through stewardship,particularly where an Asset Owneris seeking to achieve Sustainability

3.1.4

Where an Asset Owner considers engaging
in instrumental IFSI in discharging
its legal duties or in the exercise of its
discretions, it will need to assess a range
of factors, including whether the costs
involved in addressing certain systemicrisks created by some sustainability
factors are justifiable, for example, where
the risk concerned is systemic and there
are therefore limits to what any individual
actor can reasonably hope to achieve.
However, this balance between costs andoutcomes could change if the relevant
Sustainability Impact were pursued incooperation with other investors, since
any cost is likely to be spread and theaggregate impact of the whole may be
more than any individual part acting in
isolation. Similarly, the assessment may
well change if the investor’s own planned
action is considered (as it should be) in
the context of the activities of other third
parties (such as policymakers introducing
rules, say, to reduce carbon emissions)that are relevant to the sustainability
outcome sought. While we do not thinkthe law yet imposes a general duty on
Relevant Investors to collaborate topursue instrumental IFSI, in our view
Asset Owner duties are generally likely
to require them to consider, among
other things (a) whether to engage in
stewardship to secure their financial
or other stated objectives, (b) whether
the stewardship needs to be focusedon achieving Sustainability Impacts inorder to do that, (c) whether acting incollaboration with other investors is thebest way of advancing their goals and (d)to act accordingly.
3.1.5

In the United States, pension funds andmutual funds (although there is a rangeof practices) have historically been at theforefront of stewardship activities andhave influenced the behavior of companies
through direct engagement, forming
coalitions to advocate for change,88
submitting items for a vote at company
annual meetings through the shareholder
proposal process under the ExchangeAct, and developing and exercising voting
guidelines that reflect sustainability
activities and exercising votes in favor ofother shareholders’ proposals regarding
sustainability initiatives, among others.
Activities such as these are within thescope of instrumental IFSI because atleast some of them are likely to involve
attempts to get companies to do things
that directly or indirectly change theirsustainability impact. Indeed, pension
funds and mutual funds engaging in

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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these activities have offered a rangeof rationales for such stewardship forachieving long-term financial returns
through benefitting broader societal goals,
such as battling climate change.
3.1.6

534

On September 23, 2020, the SEC released
final rules that affect an Asset Owner’sability to engage directly with companies
through the submission of a shareholder
proposal that is included in an issuer’s
proxy statement and is subject to avote by all shareholders. As discussed
in Paragraph 3.1.1, this is one means ofstewardship engagement, although only
one, since much engagement does not
involve formal shareholder votes. Underthe recently revised rules, the thresholds
for submitting a shareholder proposal will
increase. Previously, shareholders holding$2,000 worth of a company’s equity
securities for a period of one-year were
eligible to submit a shareholder proposal
within the parameters described therein.89
The revised thresholds inversely correlate
length of ownership to the required equity
stake, raising the minimum ownershipamount of a company’s equity securities
to $25,000 for one year, $15,000 for two
years or $2,000 for three years.90 These
thresholds apply to each shareholder—
the rule does not permit aggregationof holdings to meet these thresholds.91
In addition, for a proposal that failed
to receive majority support to be
resubmitted, it needs to meet minimum
support thresholds to be eligible for reproposal. If a proposal does not meet theminimum support threshold, a company
may exclude the proposal for three years
following the meeting at which it failed

to meet the applicable minimum support
threshold. The SEC raised those minimum
support thresholds from 3%, 6% and
10% for one, two or three or more priorvotes in the last five years, respectively, to
5%, 15% and 25% for the same period.92
Other changes will also affect eligibility.
These changes may be perceived by someAsset Owners as limiting their ability touse shareholder votes to engage directlywith issuers and other shareholders onsustainability matters.
3.1.7

One example of a driver of change is theInvestor Stewardship Group (“ISG”), an
investor-led effort that includes over 60
U.S.-based institutional investors andglobal asset managers, including someof the most significant pension funds
and mutual funds. The ISG began as
an initiative to establish a frameworkof basic investment stewardship andcorporate governance standards for bothinvestors and companies. The ISG put
together a set of stewardship principles
for institutional investors and governanceprinciples for U.S. public companies andseeks commitments from its institutional
investor members to seek to implement
the ISG’s stewardship principles, in amanner appropriate for the relevant
investor. Although ISG is an example of
how investors can collaborate, it does
not have a stated IFSI approach in its
governance principles. That said, wherea sustainability factor presents material
risks or opportunities to a company, it
would clearly be a matter that would
need to be properly addressed through its
governance processes.

Public pension funds and private
retirement plans

3.2

Legal requirements to engage for Sustainability
Impact3.2.1

Although there is not an explicit legal
requirement to engage for Sustainability
Impact, a trustee’s duty to act in theinterest of its beneficiaries would likely
include stewardship activity that isdesigned to achieve Sustainability Impacts
if the trustee concludes that doing so
is necessary to secure their financial orother stated objectives. For example, the
DOL has ruled that trustees must use
their voting rights as an asset on behalfof the interests of a trust’s beneficiaries,93
and accordingly a trustee of a private
retirement plan should consider whether
the exercise of such voting rights isnecessary to protect such interests against
any adverse sustainability impact on theperformance of their portfolio. Pension
funds will need to consider stewardship
activity, including the use of voting rights,
if they conclude that such stewardship
activity will enable the fund to:(a) Cause a particular investee target toachieve a given sustainability impact thatwill serve to maintain or enhance suchtarget’s value in the fund’s portfolio. Thisapproach may be a more economicallyefficient means of improving theportfolio’s risk-balanced return compared
to a divestiture. Similar to the position
discussed in Paragraph 2.4.22 for atrustee, a fund manager would need todemonstrate that it engaged in a properdue diligence process that enabled it tomake a reasoned determination as to

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whether or not stewardship activity
could positively impact a portfolio’s value
or return in order to defend against a law
suit that alleged a decrease in financial
return due to such stewardship
activity ; or(b) Mitigate a systemic sustainability risk that
could adversely impact the performanceof its portfolio—either due to activity in aparticular sector or the broader economy.
In this case, a fund is more likely toconclude that it cannot address such risk
through individual stewardship but that
effective stewardship requires collective
action. In assessing collective stewardship
action, the fund will need to consider
its general chances of success, the added
costs of coordination and the need toensure that the potential benefits acrossall beneficiary cohorts satisfy the duty of
impartiality described in Paragraph 2.4.9.

issues to the attention of a company
board and announced that in 2019, it
sent 832 letters to portfolio companies
requesting action on ESG-related issues.94
The California State Teachers’ Retirement
System (“CalSTRS”), the second largest U.S.
pension fund, has rebranded its corporate
governance unit as its sustainable
investment and stewardship strategies
unit in order to reflect a proactive actionoriented program focused on long-termsustainability.95 In addition, the California
Public Employees’ Retirement System(“CalPERS”), the largest pension fundin the U.S., has supported shareholder
proposals requiring greater disclosuresof diversity of companies’ board andworkforce, as well as environmental
practices and risks.96
3.2.4

Legal freedom to engage for Sustainability Impact
3.2.2

3.2.3

535

Public pension funds and private
retirement plans have the legal freedom
and duty to engage in stewardshipfor Sustainability Impact when suchstewardship can contribute to seeking
a financial return or the preservationof assets for their beneficiaries. Indeed,
these funds have been increasingly vocal
proponents of shareholder proposals
related to sustainability.
For example, the Office of the New YorkState Comptroller, responsible for New
York State Common Retirement Fund(one of the largest pension funds in the
United States), has highlighted its useof shareholder proposals to bring ESG

3.2.5

Public pension funds and private
retirement plans increasingly form
coalitions, often also backed by the largest
funds, to campaign for sustainability
initiatives at companies. For example,
Climate Action 100+ includes more than
320 investors, which includes many
pension funds and represents over $32
trillion in assets under management.
Climate Action 100+ engages companies tocurtail greenhouse gas emissions and set
targets to achieve related goals.97 In someinstances, pension funds have partneredwith traditional financial shareholder
activists to focus on sustainability or
have actively advocated for sustainabilitychanges themselves.98
In other instances, U.S. public pension
funds and private retirement plans haveformed global alliances to advocate for

ESG stewardship using public platforms
and open letters to advocate for changes.
For example, in a letter released in March
2020, the chief executives of Japan’s
Government Pension Investment Fund(with $1.57 trillion under management
and the world’s largest pensionfund), CalSTRS and UK’s Universities
Superannuation Scheme (“USS”) declaredthat “[a]s asset owners . . . we strive toact as stewards of long-term capital,creating sustainable value by supporting
companies with a clearly defined, longterm vision for growth” and committed
to building relationships with other asset
owners that pledge to integrate ESG
factors in their investment process.99
3.2.6

In addition, on December 16, 2020,
the DOL issued a final rule regarding“investment duties” under ERISA that
address the ability of an ERISA fiduciary
to comply with the fiduciary duties ofprudence and loyalty when fiduciaries
exercise proxy voting, shareholder
rights and other activities that relate
to stewardship.100 The rule codifies
the DOL’s position that ERISA plan
fiduciary duties of prudence and loyalty
apply when deciding whether to voteproxies and exercise other shareholder
rights. Specifically, a fiduciary would
be permitted to vote proxies only when
the fiduciary “prudently determinesthat the matter being voted upon would
have an economic impact on the plan”101
and that fiduciaries would be prohibitedfrom voting proxies unless there was adetermination that the matter voted on
would have an “economic impact.”102 More

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critically, the supplementary information
published with the rule clarifies that the“use of plan assets by a plan fiduciary tofurther political or social causes that ‘haveno connection to enhancing the economic
value of the plan’s investment’ throughproxy voting or shareholder activism is aviolation of ERISA’s exclusive purpose andprudence requirements.”103 The proposed
rules had stated that ERISA fiduciaries
would have had an obligation to refrainfrom voting altogether unless the fiduciary
determined that the vote would havean economic impact on the plan.104 This
duty to refrain from voting was removed
from the final rule out of a concern thatit could lead to fiduciaries refraining
from voting altogether out of a concernof incurring liability. While the role ofstewardship in relation to ESG factors
in pursuing a plan’s financial objectives
is recognized, there is nonetheless arisk, despite the safe harbors includedin the rule, that the rule could chill thewillingness of an ERISA fiduciary toengage in stewardship activities and proxyvoting for instrumental IFSI because of
the significant review and documentationnecessary to demonstrate economic
benefits. However, on March 10, 2021, the
DOL announced that it would not enforce
the rule and instead intends to revisit thisrule, after hearing from stakeholders.105
3.3

Mutual funds

Legal requirements to engage for Sustainability
Impact3.3.1

536

We are not aware of any express
requirement on mutual funds to engage
for Sustainability Impact. The generalfactors that a mutual fund will need toconsider when engaging in instrumental
IFSI stewardship will be similar to those
applicable to pension funds in terms ofthe cost-benefit analysis of whether suchactivity will serve to maintain or enhancethe value of an individual investee orhelp guard against systemic risks to
the fund’s entire portfolio. However,there is of course a very broad range ofstated investment objectives that havebeen adopted by mutual funds, and thenature of its stated investment objective
may make a particular mutual fundmore or less likely to engage in suchstewardship. If the terms of the fund’s
prospectus set out a sustainability impact
objective, it is more likely that the fundwill conclude that stewardship represents
one of, if not the most, cost-efficientmeans of protecting and enhancing theperformance of its portfolio in a mannerthat is consistent with such statedobjective. However, if the fund does nothave a specific sustainability objective,
or is highly diversified such that its
investment in a particular investee will
not significantly alter the outcome of its
overall performance, divestiture may be amore efficient option with respect to any
particular investee if the fund concludes
that the value of such investee is likely
to be adversely affected by sustainability
factors. With respect to a systemic
sustainability risk to its entire portfolio,
a mutual fund may conclude thatstewardship activities are required as partof its legal duties to protect and enhance
its broader portfolio financial return,after having conducted the proper processreview discussed in Paragraph 3.2.1.

Legal freedom to engage for Sustainability Impact
3.3.2

3.3.3

The applicable legal framework describedin Paragraphs 2.5.8 and 2.5.9 above,
which generally sets a good faith andreasonableness standard under state law
duties of care, indicates engagement for
Sustainability Impact could be consistent
with the duty to seek financial objectives
if, in their discretion, the financial benefit
analysis of such engagement outweighs its
relevant cost.
Among companies that provide mutualfund investments, BlackRock, State
Street Global Advisors and VanguardGroup are among the most significant
in the U.S., both in terms of size ofinvestments and stewardship influence.
Each company releases stewardshipreports, detailing its respective focus andefforts on stewardship with companies.
BlackRock’s report notes that it wasawarded an A+ score for its stewardshipand governance efforts in the most recent
UN PRI assessment.106 It also discusses
in detail its efforts related to climate
and environmental risk and its views on
sustainability. It is worth noting, however,that these reports tend to be issued at theInvestment Adviser group level rather
than by or on behalf of specific mutual
funds. It is nevertheless important thatthese Investment Advisers have concluded
that as a matter of fiduciary responsibility
engaging in these activities does notconflict and, in fact, is beneficial to the
pursuit of the objectives of the mutual
funds that they manage.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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3.3.4

3.3.5

537

BlackRock has been vocal aboutincorporating sustainability
considerations into its engagement
efforts and its view that engagement
efforts form part of its role as a fiduciarywith respect to its clients’ assets because
these issues drive long-term sustainable
performance. State Street has similarlystated that it believes stewardship isa fiduciary responsibility and one of
the ways State Street can add value toportfolio companies and clients. Like
BlackRock, State Street’s annual reportsets forth its views and engagements onsustainability issues. Vanguard noted inits 2019 Investment Stewardship Annual
Report that it engaged directly with 258
companies in carbon-intensive industries
and often discussed long-term risks withmanagement representing nearly onethird of Vanguard’s engagements withcompanies.
Furthermore, Vanguard disclosed that itraised relevant environmental and social
issues at companies across a variety of
sectors and regularly asks companies how
the company’s sustainability strategy
integrates with corporate strategy.
Parsing through these statements,
however, it is notable that all three
institutions appear to be careful to linksustainability objectives to concepts thatcan be construed as improved economic
return (in BlackRock’s case, “long-term
performance,”107 in State Street’s case,“add[ed] value,”108 and in Vanguard’s case,“integ[ration] with corporate strategy”109).
In short, promoting sustainability in
pursuit of long-term performance isconsistent with instrumental IFSI because
economic return is the ultimate goal.110
3.4

stewardship expenses against the potential
benefit to the pool in question, including,for example, whether such expenses are
fairly allocated between the insurer’s own
funds and those held in connection withthe administration of its policies. Finally,
and unique to insurance companies, thedetermination to engage in instrumental
IFSI stewardship for directors should also
include consideration of whether (i) theircompany is exposed to sustainability risks
because of the sort of risks it insures and(ii) the expense of stewardship is justified
by its potential to mitigate such risks to its
financial performance.

Insurance undertakings

General insurance: Legal requirements to engage for
Sustainability Impact
3.4.1

We are not aware of any express legal
requirement on insurance companies toengage for Sustainability Impact. However,the factors that will lead directors toengage in instrumental IFSI stewardshipwill likely be similar to those applicableto pension funds. Directors will generally
need to conduct an analysis of whether
the expenses of such stewardship canbe justified to protect or enhance theperformance of its portfolio and meet thefinancial objectives of its shareholders
and policyholders as part of their dutyof care described in Paragraphs 2.5.8 and2.5.9. This may include determinations
with respect to specific investments aswell as systemic threats to the entire
portfolio. The stewardship analysis
for a director will differ depending on
the type of insurance company andassets involved, for example whether
the insurance company (a) has a statedfinancial objective that expressly or
implicitly requires such stewardship, (b)is investing in and managing the relevant
assets in connection with (or subject tothe contractual terms and conditions
applicable to) particular policies issued bysuch insurance company or (c) is investing
the proprietary assets of the company
without regard to specific policies for the
benefit of the company’s shareholders.
Different asset pools may require adifferent cost-benefit analysis of the

3.4.2

There is widespread engagement byinsurance companies in stewardship
activities relevant to sustainability.
In March 2019, the ReinsuranceGroup of America (“RGA”) was thefirst U.S. insurance firm to sign the
Principles for Responsible Investment.
Organizations and frameworks/initiatives
such as the Principles for Sustainable
Insurance (“PSI”), the Sustainable
Insurance Forum (“SIF”), the International
Association of Insurance Supervisors(“IAIS”), and the Network of Central
Banks and Supervisors for Greening the
Financial System (“NGFS”) are working
collaboratively to address sustainability
challenges in the insurance sector.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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4.

ASSET OWNERS’ ENGAGEMENT IN PUBLIC POLICY WORK TO SECURE SUSTAINABILITY IMPACT

4.1

The following section considers the extent
to which, and on what basis, each type ofAsset Owner is (a) legally required or (b)legally permitted or able to use its position
to engage in public policy work designed
to achieve positive sustainability impacts
and minimize negative sustainability
impacts for example, where these are
relevant to the value of portfolio assets.

4.2

Public pension funds and private
retirement plans

4.2.1

The position on pursuit of instrumental
IFSI public policy work related totrustee duties is broadly the same as forengagement in stewardship activities
described in Paragraph 3.2.1. As a generalmatter, trustees will need to balance thecosts associated with policy engagement
against the likely benefits to achieving
their financial objectives. There is not an
explicit legal requirement to engage inpublic policy work. However, funds should
conduct an analysis that weighs thepotential benefits against the impact of
the costs involved on their ability to meettheir financial goals, taking into accountthe likelihood of being able to bring aboutsystemic change since public policy action
will likely require collective action andnot be enterprise-specific.

4.2.2

Consistent with policy work to bringabout systemic change in pursuit of
instrumental IFSI, many pension funds
have been active in the public debate
through panel forums and open letters,such as the recent open letter advocating
for ESG integration for long-term valueauthored by the investment officers ofJapan’s public pension fund, CalSTRS andUK’s USS.111

4.3

Mutual funds

4.3.1

The position in relation to public policy
work in pursuit of instrumental IFSI isbroadly the same as for stewardship as
discussed in Paragraph 3.3.1. We are notaware of any explicit legal requirementon mutual funds to conduct public policy
work for Sustainability Impact.

4.3.2

As discussed in Paragraph 3.3.2, the legal
framework for mutual funds is flexible
enough to permit them to use theirposition to engage in public policy work
designed to achieve sustainability impact
in pursuit of the objectives of their funds.
Accordingly, as described in Paragraph3.3.3, many of the largest mutual fundowners are already active in stewardshipand public policy undertakings inconnection with advocating for systemicchange (since public policy action will
likely require collective action and not beenterprise-specific).
4.4

Insurance undertakings

4.4.1

Similar to the position with respect tostewardship described above in Paragraph3.4.1, Insurance companies are notlegally required to use their position to
engage in public policy work designed toachieve positive sustainability outcomesand minimize negative sustainability
outcomes. However, some directors may
conclude that such public policy activities
may form a part of their duty to act in
the best interests of their companies byprotecting assets against systemic risks(since public policy action will likely
require collective action and not beenterprise-specific). This is evidenced by
the fact that many insurance companies
are active in public debates through panel
forums and open letters.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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REFERENCES

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5.

ESTABLISHING NEW FUNDS TO INVEST FOR SUSTAINABILITYIMPACT AND AMENDING THE TERMS OF EXISTING ONES

5.1

The following section considers the extent
to which it is possible for an Asset Owner
to set up a fund, policy or other productwith the express objective of instrumental
or ultimate ends IFSI.

5.2

Public pension funds and private
retirement plans

5.2.1

Under state law, public pension funds
must abide by the sole interest rule,as described in Paragraphs 2.3.2 and2.3.3. Under the rule, the trustee may
not engage in collateral benefits ESG
integration for non-pecuniary objectives
without violating their fiduciary duties
to their beneficiaries, given that “soleinterest” has been interpreted to mean
financial interests; however, the rule does
permit a trustee to consider ESG factorsthat support the trustee’s fiduciary duty
to optimize risk-based investment returns.

5.2.2

As discussed in Paragraphs 2.3.2 and 2.3.3,
a trustee for a private retirement plan
would be prohibited from pursuing an
objective for a portfolio that conflicts inany way with the objective of maximizing
financial returns. The trustee must act
in a way that advances the “sole” (i.e.,sole financial) interest of the beneficiary.
Accordingly, a strategy that replaces thisoverriding financial return objective withthe objective of ultimate ends IFSI would
be inconsistent with applicable law andregulations.

5.3

Mutual funds

5.3.1

Those who want to set up funds thatincorporate IFSI into their investment
objective, as either a primary or secondary
objective, can do so, subject to including

539

appropriate disclosure in the fund’s
prospectus as to the fund’s strategy andattendant risks. Integrating an IFSI Impact
objective into an existing fund is likely
very difficult without the consent of 100%of investors (or such lesser percentage, ifany, as may be permitted by the fund’s
constitutive documents and disclosed in
the prospectus) given that investors madetheir original investment decision basedon the investment guidelines disclosed in
the prospectus made available to them atthe time of their investment.
5.3.2

5.3.3

To the extent that IFSI does not conflictwith the investment guidelines containedin the investment advisory agreement
or its fiduciary duties, such an objective
could in theory be incorporated into an
Investment Adviser’s strategy. However,most investment advisory agreements
include a precisely articulated generalstandard of care that must be compliedwith by the Investment Adviser, andcompliance with this standard andany other relevant provisions of theinvestment advisory agreement must be
carefully considered by the Investment
Adviser before any such incorporation.
Given the increased investor demandand interest in IFSI, there are a numberof mutual funds that are designed toscreen investments for ESG criteria andspecifically exclude stocks of certain
companies that do not meet thesecriteria. It would, in principle, be possible
to establish new funds with specificsustainability impact goals in a similar
way.112ACKNOWLEDGEMENTS

5.4

Life insurance products
We are not aware of any prohibition
on insurers from incorporating IFSI
into the investment objectives of theirproducts, as either a primary or secondary
objective. Any strategy connected withsuch products will need to be consistent
with director duties to act in the bestinterest of their company, as discussed in
Paragraph 2.6.15, including maintaining
sufficient reserves and liquidity to coverpolicyholder claims. In the case of life
insurance, this could mean settinga Sustainability Impact objective in
addition to, and even with priority over, afinancial return objective for the relevant
policyholder, or a unit-linked policy thatis linked to a fund with an objective thatwould involve adopting a strategy within
the scope of IFSI. In the case of generalinsurance, this could mean offeringa policy with a guarantee to relevant
policyholders that their premiums will
be invested for Sustainability Impact.113
States enact different disclosure
requirements regarding life insurance
policies. It is possible that under somestate laws, disclosure of such objective
would be required to be provided to therelevant policyholders if a life insurance
product were to be created with theintention that premiums will be invested
for Sustainability Impact, particularly ifsuch objective can impact the amountpayable if a claim is made under the
relevant policy.

EXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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6.

INVESTMENT ADVISERS’ DUTIES TO INVEST FOR SUSTAINABILITY IMPACT

6.1

This section considers the extent to which,and in what circumstances, an Investment
Adviser is (a) legally required or (b) legallypermitted to Invest for Sustainability
Impact on behalf of an Asset Owner orotherwise, in each of the three ways
contemplated in sections 2–4.

6.3.1

Overarching considerations
6.2

6.3

540

Investment Advisers’ obligations are
generally owed to Asset Owners under
their investment advisory contract, not tobeneficiaries of the funds they manage.
Investment advisory contracts typically
include provisions preventing non-parties,
such as beneficiaries, from enforcing
the terms of the agreement. Further, aninvestment advisory contract will typicallyrequire an Investment Adviser to manage
the fund portfolio in accordance with theinvestment guidelines disclosed in thefund’s prospectus.
To the extent that an Investment Adviser
breaches its contract and the investors
suffer losses as a result, the Asset Owner
will have a fiduciary duty to its investors
to enforce its rights and remedies against
the Investment Adviser and seek damages
for such breach in order to recovervalue for its investors. Furthermore,
if an Investment Adviser breaches its
obligation, as part of its duty of care, tomake a reasonable inquiry into, and havea reasonable understanding of, its clients’investment objectives, the Asset Owner
would have recourse to the Investment
Adviser for such breach and would likely
view pursuing such recourse as part of its

fiduciary duty to its shareholders in orderto recover value for them.

(c) applies to the entire relationship between
the Investment Adviser and its client; andAccordingly, in the case of a mutual fund,an Investment Adviser will likely requirethat any new investment objective beapproved by, if applicable, the relevant
requisite percentage of beneficiaries
and a concomitant amendment to theinvestment guidelines in an updated
prospectus and investment advisory
agreement, thereby protecting itself fromcontractual liability.

(d) may not be waived.116

Legal obligation to IFSI

6.4

Powers of investment and divestment
6.4.1

6.4.2

Investment Advisers also have fiduciary
duties under Section 206 of theInvestment Advisers Act.114 Section 206
applies to both SEC and state-registered
Investment Advisers, as well as other
Investment Advisers that are subject
to the territorial jurisdiction of theInvestment Advisers Act but are notrequired to be registered under the Act.
The duties are not explicitly defined, but
the standard and definition is derived
from a series of SEC interpretations andjudicial precedent. Most recent among
these is an interpretation of the standardof conduct for investment advisers (the“Advisers Act Release”).115
The Release makes it clear that thefiduciary duty:(a) is composed of both a duty of care and a
duty of loyalty;(b) is principles-based;

Duty of care
6.4.3

6.4.4

The duty of care includes: (a) the duty toprovide advice that is in the best interest117
of the client and (b) the duty to provide
advice and monitoring throughout therelationship.
The duty of care:(a) includes a duty to provide investment
advice that is suitable for the client (which
would arguably include taking account ofa client’s sustainability objectives);(b) requires an Investment Adviser to makea reasonable inquiry into, and have areasonable understanding of, its clients’investment objectives (including, in thecase of an investment adviser whose client
is a registered investment company or a
private fund, a reasonable understandingof the fund’s investment guidelines andobjectives, including any sustainability
objectives); and(c) requires an Investment Adviser to havea reasonable belief that the advice it
provides is in the best interest of the client
based on those objectives.
6.4.5

In order to develop a reasonable
understanding of its clients’ investment
objectives, the Advisers Act Release
recommends that:(a) In the case of retail clients, an Investment
Adviser should develop an understandingof the investment profile of the client by,

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

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at a minimum, (i) making a reasonableinquiry into the client’s financial
situation, level of financial sophistication,
investment experience and financial goals
and (ii) updating the client’s investment
profile in order to maintain a reasonable
understanding of the client’s investment
objectives and adjust the advice to any
changed circumstances; and(b) In the case of institutional clients, an
Investment Adviser should develop anunderstanding of the investment mandate
by gaining a reasonable understanding of
the client’s objective within that portfolio,
but not the client’s objectives within its
entire investment portfolio.
Duty of loyalty
6.4.6

6.4.7

6.4.8

541

The duty of loyalty requires that an
Investment Adviser not subordinate its
clients’ interests to its own. To fulfil its
duty of loyalty, an Investment Adviser
must make full and fair disclosure to its
clients of all material facts relating to
the advisory relationship, including thecapacity in which the firm is acting withrespect to the advice provided and any
conflicts of interest.
This combination of care and loyalty
obligations has been characterized as
requiring the investment adviser to act
in the “best interest” of its client at all
times and “to adopt the principal’s goals,
objectives, or ends.”118
Whether the investment management
advice provided to the client is in aclient’s best interest must be evaluatedin the context of the portfolio that theadviser manages for the client and theclient’s objectives, including its tolerance
for higher risk in exchange for higher
expected returns. An adviser’s fiduciary
duty applies to all investment advice
that the investment adviser provides toclients, including advice about investment
strategy.
6.4.9

A reasonable belief that investment
advice is in the best interest of aclient also requires that an adviser
conduct a reasonable investigation
into the investment so as not to baseits advice on materially inaccurate or
incomplete information. The SEC hastaken enforcement action where an
investment adviser did not independentlyor reasonably investigate securities before
recommending them to clients.119

6.4.10 Finally, an investment adviser’s duty ofcare also encompasses the duty to provide
advice and monitoring at a frequency
that is in the best interest of the client,taking into account the scope of theagreed relationship. For example, when
the adviser has an ongoing relationshipwith a client and is compensated with aperiodic asset-based fee, the adviser’s duty
to provide advice and monitoring will be
relatively extensive as is consistent with
the nature of the relationship. Conversely,
absent an express agreement regarding
the adviser’s monitoring obligation,
when the adviser and the client have arelationship of limited duration, such as
for the provision of a one-time financial
plan for a one-time fee, the adviser isunlikely to have a duty to monitor. In
other words, in the absence of any agreed
limitation or expansion, the scope ofthe duty to monitor will be indicated by
the duration and nature of the agreed
advisory arrangement.
6.4.11 It is clear, therefore, that an Investment
Adviser, as part of its duty of care, must
consider the client’s objectives when
determining what is suitable for andin the best interests of its clients, notsubstituting its own preferences for thoseof the client. Further, an Investment
Adviser cannot take actions in breach of
the then-current investment guidelines in
the investment advisory agreement. Under
its duty of loyalty, if the client specificallymandates an instrumental or ultimate
ends IFSI in its investment guidelines, theInvestment Adviser would be required tofollow it. However, if the guidelines are
silent on this, the Investment Adviser
could only pursue sustainability impact
goals in the way it uses its investment
powers where this is consistent withseeking to achieve the required financial
investment objective (i.e. instrumental
IFSI). That said, in practice Investment
Advisers may feel reluctant to do soin these circumstances if it creates arisk of reduced financial performance,
for example, in the short-term. Using
investment powers to pursue an ultimate
ends IFSI strategy would not be possible
absent an explicit mandate.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa

Engagement to achieve Sustainability Impact

United Kingdom

6.4.12 As noted, stewardship may involve trying
to change the behavior of a company(i.e., its impact) in some way relevant tosustainability.

United States

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6.4.13 As with the use of investment powers
where an investment management
contract is silent on the question ofsustainability impact goals, in principle an
Investment Adviser would still be able toengage in stewardship intended to achievegoals of that sort where it concludes
that doing so is likely to be effectivein pursuing its financial investment
objective. In practice, the Investment
Adviser would likely need to be cautiousthat any activity did not damage
investment performance, although inprinciple it should be possible to defend
actions taken in pursuit of instrumental
IFSI when the guidelines were silent as
being consistent with its clients’ financial
interests.
6.4.14 As discussed above in Paragraphs 3.3.3
through 3.3.5, among companies thatprovide mutual fund investments,
BlackRock, State Street Global Advisors,and Vanguard Group are among the mostsignificant in the U.S. in terms of theirstewardship influence. They have engaged
in stewardship activities that advocate for
Sustainability Impacts that judge to put
long-term financial performance at risk.
Each company has released stewardshipreports, detailing its respective focus andefforts on stewardship with companies.

Public policy work to achieve Sustainability Impact

ACKNOWLEDGEMENTS

6.4.15 We are not aware of any requirement toundertake public policy engagement inrelation to the Investment Adviser.

EXECUTIVE SUMMARY

6.4.16 As noted above, an Investment Adviser’s
duties will be framed by the contractual
terms of its mandate. Where the mandate
is silent as to Sustainability Impact, we
do not consider there to be any legal
requirement for Investment Advisers toengage in public policy work to Invest for
Sustainability Impact.
6.5

Legal freedom to IFSI

6.5.1

An Investment Adviser is under a duty
to follow the terms of its mandate fromits client and where such mandate issilent, its duty includes seeking a longterm return for its client. As discussed
in Paragraph 6.4.14, many of the largest
investment advisers have stated publiclythat to achieve such long-term return for
their client requires them to invest in
and advocate for Sustainability Impacts.
Of course, such duty to advocate forlong-term returns for their clients cannot
conflict with their other fiduciary duties,
such as the duty of loyalty.

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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7.

LEGAL LIABILITY TO THIRD PARTIES FOR THE NEGATIVE SUSTAINABILITY IMPACT OF
ENTERPRISES IN WHICH PORTFOLIOS ARE INVESTED

7.1

This section considers the extent towhich, regardless of the legal rules
under which it is required to operate
and its constitution, an Asset Owner
could be legally liable to third parties
for the negative Sustainability Impact
of enterprises in which it invests, andwhether an Investment Adviser could also
be liable because of its role in assisting
the Asset Owner to invest in the relevant
enterprise and steward its investment.

7.2

Asset Owners

7.2.1

It is difficult to hold Asset Owners or
Investment Advisers liable to third parties
for the negative Sustainability Impact
of enterprises in which investments are
made. Out of more than 120 cases in the
U.S. that we have identified relating tosuch claims, all were unsuccessful on suchclaims due to constitutional grounds (lackof standing, justiciability) and evidentiarygrounds (difficult to prove that allege
tortious behavior caused negative
Sustainability Impact).

7.2.2

The bar is high to make a successful
claim that an Asset Owner or theInvestment Adviser should be liable forhistorical emissions or public statements/
disclosures. Traditional notions ofvicarious liability inform the litigation
risk for Asset Owners and Investment
Advisers with regard to claims arisingfrom both such claims. Accordingly, if an
Asset Owner or Investment Adviser does
not control an entity making ESG-related
statements and is not involved in making
public statements about sustainability thatare later challenged, it will likely not beheld liable for such statements. In otherwords, the Asset Owners or Investment
Advisers would not be held liable merely
for their investment activities, but only ifthey step out of their traditional roles into
one that is controlling the enterprises inwhich they invest.
7.2.3

However, they can still be held liablewith regards to more localized negative
Sustainability Impacts under certain
federal statutes, like the Comprehensive
Environmental Response, Compensationand Liability Act (“CERCLA”),120 whichfacilitates environmental clean-up, andanalogous state laws.

7.3

Investment Advisers

7.3.1

The legal liability faced by Investment
Advisers to third parties is similar to that
faced by Asset Owners, as described in
Paragraph 7.2.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

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8.

THE GROWING IMPORTANCE OF TAKING ACCOUNT OF ESG ANDSUSTAINABILITY FACTORS WHERE THESE ARE “FINANCIALLY MATERIAL”

8.1

Building on the findings of the Freshfields
Report of 2005,121 it has become
increasingly important for Asset Owners
and their Investment Advisers to take
ESG factors into account in managing
investment portfolios because of theway in which they could be material
to achieving the financial investment
objectives of the relevant Asset Owner or
Investment Adviser in accordance with
their legal duties. The main reasons are
summarized below.

8.2

8.3

A recent empirical study on thecorrelation between ESG criteria andcorporate financial performance thatcombined the findings of 2,200 individual
studies concluded that taking ESG factors
into account when investing has a positive
impact on financial performance overtime, particularly in industries that can be
negatively impacted by ESG issues, suchas fossil fuel-related investments that canbe impacted by climate change effects.122
Another recent study back-tested ESG
metrics for materiality and found that a
strategy that solely based its investment
decisions on these metrics outperformed a
global composite of stocks.123
ESG proponents have pointed to an MSCI
analysis which found that each of the four
MSCI ESG indexes outperformed theirparent indexes during the first quarterof 2020.124 The impacts that some ESG
factors can have on financial performanceand long-term value creation, along withinvestor demand for information, will

likely lead to broader financial disclosure.
The recent outperformance of ESG-oriented
funds may accelerate the number of Asset
Owners pressing their Investment Advisers
and Investment Managers to pursue ESG
investment products and strategies.
8.4

8.5

8.6

materially impact the investment’s
financial performance long-term.
8.7

Knowledge about the systemic impact
of declining sustainability is becoming
increasingly widespread and is supported
by various studies. According to one
estimate by the Intergovernmental
Panel on Climate Change, as reported by
Moody’s Analytics, climate change alone
has the potential to destroy $69 trillion in
global economic wealth through 2100.125
Sustainability efforts surrounding humancapital management (“HCM”) represent
one of the most significant governancethemes emerging in 2020, which sits at
the intersection between investors, theworkforce and consumers. As we have
moved to a talent-based economy, HCM
has become a “mission critical asset.”126
Investors, including those focused on IFSI,
are likely to focus on these issues. It is also
increasingly likely that investors view theseissues as financially material, as the ability
to attract and retain and compensate
a workforce is critical to the success ofcompanies in a talent-based economy.
Because of this growing body of evidence
and related projections, it will likely
become increasingly important for
Asset Owners to incorporate ESG aspects
in their decision-making process,particularly where ESG factors canWhile Asset Owners may increasingly
incorporate ESG factors independently
based on their assessment of their impact
on financial performance, there is also
evidence that client demand constitutes amajor driving force behind incorporating
ESG factors into investment decisions.127
There has been increasing interest fromconsumers and investors in “sustainable”
or “socially responsible” brands andinvestments. In response, the Deloitte
Center for Financial Services (DCFS)
expects client demand to drive ESGmandated assets to constitute half of all
professionally managed investments in
the U.S. by 2025, with potentially 200 new
ESG funds by 2023.128

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

Brazil8.8

Financial materiality

Canada8.8.1

We believe the determination of what
is financially material is a decision foreach investor based on its own particular
circumstances. The key legal consideration
will be the investor’s investment objective.
A sustainability factor is likely to bematerial, in our view, if a reasonable
investment professional would conclude
that there is a reasonable prospect of it
having (alone or in combination withother factors) a significant impact (within
the investment time horizon) on theinvestor’s ability to achieve its investment
objective over the relevant period.

China

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Elizabeth Bieber, Melina E De Bona, Lori Goodman, Timothy Harkness, Lauren Kaplin, Hannah Khalifeh, Brian Lewis, Sam Lowenstein, Laurie Morgan,
Travis Panneck, Jerome Ranawake, Brian Rance, Jordan Salzman, Elvira Sihvola, Altin Sila, Aaron Voloj Dessauer and Timothy Wilkins
544

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

UNITED STATESCONTENTSFOREWORDSINTRODUCTION
1

Investment Advisers are often referred to as Investment Managers inother jurisdictions.

24

2See, e.g., Max M. Schanzenbach & Robert H. Sitkoff, Reconciling
Fiduciary Duty and Social Conscience, 72 Stan. L. Rev. 381 (2020).

25

29 U.S.C § 1104(a)(1)(A).

3

See Schanzenbach & Sitkoff, supra note 2.

26

29 U.S.C. § 1105(a).

4Fiduciaries are able to waive the corporate opportunities doctrine,
which precludes officers and directors from personally benefittingfrom opportunities that belong to the corporation, in certain
jurisdictions. See Del. Code Ann. tit. 8, § 122(17).

27

ERISA provides an exception for assets of a plan which consist of
insurance contracts or policies, assets of an insurance company orplan which are held by an insurance company, and a plan which
consists of retirement accounts. 29 U.S.C. § 1103(b).

28See, e.g., Thole v. U.S. Bank, N.A., 140 U.S. 1615, 1619 (2020).

29

29 U.S.C. § 1104(a)(1)(B), known as the “prudent man standard ofcare.”

5

See, e.g., Cal. Const. art. XVI, § 17(b).

6

See Schanzenbach & Sitkoff, supra note 2.

ERISA, U.S. Dep’t of Lab., https://www.dol.gov/general/topic/healthplans/erisa (last visited Mar. 24, 2021).

46

Id.

34

See Restatement (Second) of Trusts § 227 cmt. o.

4735

Restatement (Third) of Trusts § 82.

36

Varity Corp. v. Howe, 516 U.S. 489, 514 (1996).

Emp. Benefits Sec. Admin., U.S. Department of Labor Releases
Statement on Enforcement of its Final Rules on ESG Investments,
Proxy Voting by Employee Benefit Plans, U.S. Dep’t of Lab. (Mar. 10,2021), https://www.dol.gov/newsroom/releases/ebsa/ebsa20210310.

37

Under U.S. law, government agencies are granted authority to
promulgate rules that have force of law. Administrative Procedure
Act, 5 U.S.C. § 553 (2006). While DOL bulletins lack force of law, they
are persuasive authority.

48

Id.

49

As noted in the introduction, this survey does not purport to be a
study of all applicable state law.

50

White v. Pub. Emps. Ret. Bd., 268 P.3d 600, 608 (Or. 2011) (emphasis
added).

51

See, e.g., Susan Gary, Best Interests in the Long Term: Fiduciary
Duties and ESG Integration, 90 Colo. L. Rev. 731 (2019), http://
lawreview.colorado.edu/wp-content/uploads/2019/04/8.
-Gary_revised_4.17.pdf.

52

See Gary, supra note 53, at 795.

53

S.B. 195, 149th Gen. Assemb. (Del. 2018) (enacted), https://legis.
delaware.gov/BillDetail/26606.

54

Del. Code tit. 12, § 3304-3308 (Apr. 8, 2020), https://delcode.delaware.
gov/title12/title12.pdf (pp. 99-101).

55

Uniform Prudent Investor Act §1(b) (Unif. Law Comm’n 1994).

56

As noted in Paragraph 2.4.9, the Supreme Court, in interpreting
ERISA as applicable to private retirement funds, has interpreted
the “sole interest” rule as requiring a trustee to optimize the riskbalanced return as relevant to the investment objectives of the trust.

Japan

57

DOL has recognized that in a “tie-break” circumstance, where two
investment options have identical projected risks and returns, atrustee may consider non-pecuniary factors as a tie-breaker. While
DOL’s guidance applies only to private retirement plans, the same
principle likely applies to public pension funds.

South Africa

9

Oliver Milman, Biden’s Clean Energy Plan Would Cut Emissions
and Save 317,000 Lives, The Guardian (July 12, 2021), https://www.
theguardian.com/us-news/2021/jul/11/biden-administration-cleanenergy-climate-crisis.

32

29 U.S.C. §1104 (a)(1)(B).

33

Allison Herren Lee, A Climate for Change: Meeting Investor
Demand for Climate and ESG Information at the SEC, U.S. Secs.
& Exch. Comm’n (Mar. 15, 2021), https://www.sec.gov/news/speech/
lee-climate-change; Allison Herren Lee, Public Input Welcomedon Climate Change Disclosures, U.S. Secs. & Exch. Comm’n (Mar.
15, 2021), https://www.sec.gov/news/public-statement/lee-climatechange-disclosures.

13

Stacy Cowley et al., Biden’s Picks for Financial Regulator Jobs
Emphasize Transparency and Fairness, N.Y. Times (Mar. 2, 2021),
https://www.nytimes.com/2021/03/02/business/sec-cfpb-genslerchopra-hearing.html.

14

Retirement Plans Benefits and Savings, Fiduciary Responsibilities,
U.S. Dept’t of Lab., https://www.dol.gov/general/topic/retirement (lastvisited Mar. 24, 2021).

15

Cal. Const. art. XVI, § 17(b). California courts have upheld thisprovision. See, e.g., In re Ret. Cases, 110 Cal. App. 4th 426, 472(2003).

16

N.Y. Retire. & Soc. Sec. § 177(9)(b) (2015).

17

Restatement (Third) of Trusts § 77(1) (Am. Law Inst. 2007).

18

Uniform Prudent Investor Act §2(a) (Unif. Law Comm’n 1994); see,e.g., N.Y. Est. Powers & Trusts Law § 11-2.3(a).

19

Uniform Prudent Investor Act §2(a).

20

Id. §2(b), 3.

21

Restatement (Third) of Trusts § 79(1) (Am. Law Inst. 2007).

22

Id. § 79(1) cmt. c.

23

Id. For states that have not officially incorporated the duty of
impartiality into state law, courts may still impose this duty byrelying on common law (i.e., judicial precedent and other persuasive
authority).

545

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSI

29 U.S.C. § 1104(a)(1)(C); see also Restatement (Third) of Trusts §90(a)–(b).

Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 420–21 (2014)(quoting 29 U.S.C. §1104(a)(1)(A)(i)-(ii)).

12

A. INVESTING FORSUSTAINABILITY IMPACT

The Final Rule does not explicitly define which factors are“pecuniary” and “non-pecuniary,” but explicitly states that ESG factors
can be pecuniary in certain situations. Id.

Restatement (Third) of Trusts § 78(1) cmt. f.

31

Id.

EXECUTIVE SUMMARY

4530

See, e.g., Exec. Order No. 14,030, 86 Fed. Reg. 27,967 (May 20,2021) (directing various agencies to develop a government-wide
assessment of climate-related financial risk).

11

ACKNOWLEDGEMENTS

Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 72846(Nov. 13, 2020), available at https://www.govinfo.gov/content/pkg/
FR-2020-11-13/pdf/2020-24515.pdf.

And, similarly, instrumental IFSI.

8SEC Announces Enforcement Task Force Focused on Climate and
ESG Issues, U.S. Secs. & Exch. Comm’n (Mar. 4, 2021), https://www.
sec.gov/news/press-release/2021-42.

The 2015 Bulletin, for example, posits that because a trustee “should
appropriately consider factors that potentially influence risk andreturn,” and because “[e]nvironmental, social, and governance issues
may have a direct relationship to the economic value of the plan’sinvestment,” ESG factors “are proper components of the fiduciary’s
primarily analysis of the economic merits of the competinginvestment choices.” IB 2015-01, 80 Fed Reg. at 65136. The 2018
Bulletin recognizes that “there could be instances when otherwise
collateral ESG issues present material business risk or opportunities
to companies that company officers and directors need to manage
as part of the company’s business plan and that qualified investment
professionals would treat as economic considerations undergenerally accepted investment theories.” FAB 2018-01, at 2.

44

7

10

43

38

Interpretive Bulletin Relating to the Fiduciary Standard Under ERISAin Considering Economically Targeted Investments, 80 Fed. Reg.
65135 (Oct. 26, 2015) [hereinafter IB 2015-01].

39

Emp. Benefits Sec. Admin., U.S. Dep’t of Lab., Field Assistance
Bulletin No. 2018-01, at 2 (2018) [hereinafter FAB 2018-01].

40

IB 2015-01, 80 Fed. Reg. at 65136.

41

FAB 2018-1, at 2.

42

Deutsche Asset & Wealth Management, ESG & Corporate Financial
Performance: Mapping the Global Landscape (2015), https://www.
unepfi.org/fileadmin/events/2018/sydney/ESG-and-CorporateFinancial-Performance.pdf; Asset Mgmt. Working Grp., UN Env’t
Programme Fin. Initiative & Mercer, Demystifying Responsible
Investment Performance: A Review of Key Academic and Broker
Research on ESG Factors (2007), https://www.unepfi.org/fileadmin/
documents/
Demystifying_Responsible_Investment_Performance_01.pdf;
Christophe Revelli & Jean-Laurent Viviani, Financial Performanceof Socially Responsible Investing (SRI): What We Have Learned?
A Meta-Analysis, 24 Bus. Ethics, Env’t & Resp. 158 (2015), https://
onlinelibrary.wiley.com/doi/abs/10.1111/beer.12076; Esther Whieldon
et al., ESG Funds Outperform S&P 500 Amid COVID-19, Helped byTech Stock Boom, S&P Global Mkt. Intel. (Aug. 13, 2020), https://www.spglobal.com/marketintelligence/en/news-insights/latest-newsheadlines/esg-funds-outperform-s-p-500-amid-covid-19-helped-bytech-stock-boom-59850808; Audrey Cher, Sustainable Funds are
Outperforming Their Peers During the Pandemic, BNP Paribas
Says, CNBC (June 2, 2020), https://www.cnbc.com/2020/06/02/
esg-funds-outperforming-peers-during-coronavirus-pandemic-bnpparibas.html. However, it should be acknowledged that there is andhistorically has been some evidence that shows the opposite.

58

Interpretive Matters Concerning Independent Directors ofInvestment Companies, 64 Fed. Reg. 59877 (Oct. 14, 1999), https://www.sec.gov/rules/interp/ic-24083.htm.

59

See Lucian A. Bebchuk et al., The Agency Problems of Institutional
Investors, 31 J. Econ. Persps. 89, 102 (2017).

60

U.S. Secs. & Exch. Comm’n, Mutual Funds and ETFs: A Guide for

C. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceNetherlands

United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

UNITED STATESCONTENTSFOREWORDSINTRODUCTION
Investors (2016), https://www.sec.gov/investor/pubs/sec-guide-tomutual-funds.pdf.
61

Unit Investment Trusts (UITs), U.S. Secs. & Exch. Comm’n, https://www.investor.gov/introduction-investing/investing-basics/glossary/
unit-investment-trusts-units (last visited Mar. 24, 2021).

62

Closed-end funds make up a minority of mutual funds available toinvestors and thus have not been included here as a primary type ofmutual fund.

63

Id.

64

Laws and Rules, U.S. Secs. & Exch. Comm’n, https://www.sec.gov/
investment/laws-and-rules (last visited Mar. 24, 2021).

65

Mutual Fund Prospectus, U.S. Secs. & Exch. Comm’n (July 28, 2010),
https://www.sec.gov/fast-answers/answersmfprospectustipshtm.html.

66

U.S. Secs. & Exch. Comm’n, Div. of Inv. Mgmt., Fund Disclosure
Reflecting Risks Related to Current Market Conditions (2016), https://www.sec.gov/investment/im-guidance-2016-02.pdf.

67

Chair Gary Gensler, Prepared Remarks Before the AssetManagement Advisory Committee (July 7, 2020), https://www.sec.
gov/news/public-statement/gensler-amac-2021-07-07.

68

See U.S. Secs. & Exch. Comm’n, Rules Related to Investment
Companies and Investment Advisers to Address Matters Relating toEnvironmental, Social and Governance Factors (2021), https://www.
reginfo.gov/public/do/eAgendaViewRule?pubId=202104&RIN=3235AM96.

69

70

See Jon Hale, The Number of Funds Considering ESG Explodes in
2019, Morningstar(Mar. 30, 2020), https://www.morningstar.com/articles/973432/thenumber-of-funds-considering-esg-explodes-in-2019.
Environmental, Social and Governance (ESG) Funds – Investor
Bulletin, U.S. Secs. & Exch. Comm’n (Feb. 26, 2021), https://www.
sec.gov/oiea/investor-alerts-and-bulletins/environmental-social-andgovernance-esg-funds-investor-bulletin.

71

Dodd–Frank Wall Street Reform and Consumer Protection Act, Pub.
L. No. 111-203,
124 Stat. 1376 (2010).

72

Federal Insurance Office, U.S. Dep’t of the Treasury, https://home.
treasury.gov/policy-issues/financial-markets-financial-institutionsand-fiscal-service/federal-insurance-office (last visited Mar. 22, 2021).

73

Federal Insurance Office (FIO), Nat’l Ass’n of Ins. Comm’rs (Feb. 12,2020), https://content.naic.org/cipr_topics/topic_federal_insurance_
office_fio.htm.

74

31 U.S.C. § 313(c)(1)(G).

75

31 U.S.C. § 313(c)(1)(E)–(F).

76

See Michael S. Barr, Howell E. Jackson & Margaret E. Tahyar, Financial
Regulation: Law and Policy 428 (2021).

77

Financial Stability Oversight Council, U.S. Dep’t of the Treasury,
https://home.treasury.gov/policy-issues/financial-markets-financialinstitutions-and-fiscal-service/fsoc (last visited Nov. 13, 2020).

78

See 12 U.S.C. § 5323.
About the NAIC, Nat’l Ass’n of Ins. Comm’rs, https://content.naic.org/
index_about.htm (last visited Mar. 22, 2021).

83

Kris DeFrain, U.S. Insurance Financial Regulatory Oversight andthe Role of Capital Requirements, CIPR Newsl. (Nat’l Ass’n of Ins.
Comm’rs & the Ctr. for Ins. Pol’y & Res.), Jan. 2012, https://www.naic.
org/cipr_newsletter_archive/vol2_oversight.htm.

84

We note that it is unlikely that such policies specified how
investment of premiums will be conducted, so this is unlikely topresent a barrier in practice.

85

See Robert G. Eccles & Svetlana Klimenko, The Investor Revolution,
Harv. Bus. Rev. (May–June 2019), https://hbr.org/2019/05/the-investorrevolution.

86

17 C.F.R. § 240.14a-8 (2020).

87

See, e.g., Investment Stewardship, BlackRock, https://www.
blackrock.com/corporate/about-us/investment-stewardship (lastvisited Mar. 22, 2021).

88

For example, in 2017, the New York State Pension Fund, the thirdlargest public pension fund in the U.S. with $184.5 million in assets,joined the Portfolio Decarbonization Coalition, which aims topromote carbon efficiency by mobilizing institutional investors todecarbonize their portfolios. New York Pension Fund Joins MultiBillion-Dollar International Investors To Reduce Carbon Footprint,
UN Env’t Programme (Jan. 24, 2017), https://www.unep.org/newsand-stories/press-release/new-york-pension-fund-joins-multi-billiondollar-international.

89

17 C.F.R. § 240.14a-8 (2019).

90

Procedural Requirements and Resubmission Thresholds Under
Exchange Act Rule 14a-8, Exchange Act Release No. 34-89964, 85
Fed. Reg. 70,240 (Nov. 4, 2020).

91

Id.

92

Id.

93

U.S. Dep’t of Lab., Pension & Welfare Benefits Admin., Opinion Letteron Avon Products, Inc. Employees’ Retirement Plan n.4 (Feb. 23,
1988), 1988 WL 897696 at *3 n.4

942019 Corporate Governance Stewardship Report, Off. of the N.Y. St.
Comptroller, https://www.osc.state.ny.us/files/reports/special-topics/
pdf/2019-corporate-governance-stewardship-report.pdf (last visited
Apr. 2, 2021).

95

12 U.S.C. § 5311(a)(4)(B).

80

Designations, U.S. Dep’t of the Treasury, https://home.treasury.gov/
policy-issues/financial-markets-financial-institutions-and-fiscalservice/fsoc/designations (last visited Mar. 22, 2021).

Hazel Bradford, Public Funds Taking the Lead in Spectacular Boomof ESG, Pensions & Invs. (Aug. 19, 2019, 12:00 AM), https://www.
pionline.com/special-report/public-funds-taking-lead-spectacularboom-esg.

96

Corporate Engagements, CalPERS (Jan. 11, 2021), https://www.
calpers.ca.gov/page/investments/corporate-governance/corporateengagements.

97

Eccles & Klimenko, supra note 94.

98

For example, CalPERS and CalSTRS are known for their shareholder
activism, including by way of proxy voting to encourage
environmental sustainability practices. The Importance of Corporate
Engagement on Climate Change, CalPERS, https://www.calpers.
ca.gov/docs/corporate-engagement-climate-change.pdf (last visitedMar. 22, 2021).

Id.

79

546

81
82

99

Christopher J. Ailman et al., Our Partnership for Sustainable CapitalMarkets, Gov’t Pension Inv. Fund (July 6, 2020), https://www.gpif.
go.jp/en/investment/Our_Partnership_for_Sustainable_Capital_
Markets.pdf.

ACKNOWLEDGEMENTS

100

Fiduciary Duties Regarding Proxy Voting and Shareholder Rights, 85
Fed. Reg. 81,658 (Dec. 16, 2020).

EXECUTIVE SUMMARY

101

Id. at 81,695.

102

Id.

103

Id. at 81,659 (quoting Interpretive Bulletin Relating to Exercise of
Shareholder Rights, 73 Fed. Reg. 61,731, 61,734 (Oct. 17, 2008)).

104

Id. at 81,665.

105

Emp. Benefits Sec. Admin., US Department of Labor Releases
Statement on Enforcement of Its Final Rules on ESG Investments,
Proxy Voting by Employee Benefit Plans, U.S. Dep’t of Lab. (Mar. 10,2021), https://www.dol.gov/newsroom/releases/ebsa/ebsa20210310.

106BlackRock Earns Straight A’s for Transparency by Principles for
Responsible Investment, BlackRock (Sept. 9, 2020), https://www.
blackrock.com/corporate/newsroom/press-releases/article/corporateone/press-releases/blackrock-earns-straight-a-for-transparency.

107BlackRock, 2019 Investment Stewardship Annual Report 9 (2019),
https://www.blackrock.com/ corporate/literature/publication/blkannual-stewardship-report-2019.pdf.

108

State Street Global Advisors, Stewardship Report 2018–19, at 2(2019), https://www.ssga.com/library-content/products/esg/annualasset-stewardship-report-2018-19.pdf.

109

Vanguard, Investment Stewardship: 2019 Annual Report 12 (2019),
https://about.vanguard.com/investment-stewardship/perspectivesand-commentary/2019_investment_stewardship_annual_report.pdf

110

See Blackrock, supra note 116 (“[I]n our experience, companies
with leading practices in [managing and reporting on the material
environmental and social impacts of their operations] are more
likely to deliver sustainable financial returns.”); State Street Global
Advisors, supra note 117 (“Our approach to proxy voting and issuer
engagement is premised on the belief that companies that adopt
robust and progressive governance and sustainability practices are
better positioned to generate long-term value and manage risk.”);Vanguard, supra note 118 (“We believe that good governancepractices . . . are the foundation on which a company’s board of
directors can build enduring shareholder value.”).

Brazil111

Ailman et al., supra note 106.

112

See, e.g., Vanguard FTSE Social Index Fund Investor Shares (VFTSX),
Vanguard https://investor.vanguard.com/mutual-funds/profile/
VFTSX (last visited Mar. 22, 2021); BGF Sustainable Energy Fund,BlackRock, https://www.blackrock.com/americas-offshore/products/
229299/blackrock-new-energy-a2-usd-fund (last visited Mar.
22, 2021); PARWX Parnassus Endeavor Fund Investor Shares,
Parnassus Invs., https://www.parnassus.com/parnassus-mutual-funds/
endeavor/investor-shares (last visited Mar. 22, 2021).

Japan

113

For example, Lemonade, a renters and homeowners insurancecompany, charges policyholders a flat fee and, at the end of eachyear, invests unclaimed money to a nonprofit of the policyholder’schoosing. The Lemonade Giveback, Lemonade, https://www.
lemonade.com/giveback (last visited Mar. 22, 2021).

114

15 U.S.C. § 80b-6.

115

Commission Interpretation Regarding Standard of Conduct for

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

CanadaChina

European Union
FranceNetherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKING

UNITED STATESCONTENTSFOREWORDSINTRODUCTION
Investment Advisers, Investment Advisers Act Release No. 5248, 84
Fed. Reg. 33,669 (July 12, 2019).
116

Id. at 33,671–72.

117

Under SEC releases, what it means for an Investment Adviser to act
in the “best interest” of a client is not clearly defined. Generally, an
Investment Adviser “must, at all times, serve the best interest of its
client and not subordinate its client’s interest to its own. In otherwords, the investment adviser cannot place its own interests aheadof the interests of its client.” Id. at 33,671.

118

Commission Interpretation Regarding Standard of Conduct for
Investment Advisers, 84 Fed. Reg. at 33,671.

119

For example, on November 6, 2018, the SEC announced charges
against Pennant Management, Inc., an Investment Adviser, forfailing to perform adequate due diligence and monitoring of certain
investments offered to clients. SEC Charges Advisory Firm with Due
Diligence and Monitoring Failures, U.S. Secs. & Exch. Comm’n (Nov.
6, 2018), https://www.sec.gov/enforce/ia-5061-s.

120

United States v. USX Corp., 68 F.3d 811, 825 (3d Cir. 1995) (holdingthat CERCLA liability may be imposed upon shareholders based
on “a showing that the person sought to be held liable actuallyparticipated in the liability-creating conduct”); see also United Statesv. Kayser-Roth Corp., 910 F.2d 24, 26 (1st Cir. 1990) (finding thatan “analysis of the statute and its legislative purpose and history
reveals no reason why a parent corporation cannot be held liable
as an operator under CERCLA”); United States v. A & N Cleaners& Launderers, Inc., 788 F. Supp. 1317, 1331 (S.D.N.Y. 1992) (“[C]ourts generally resolve ambiguities in CERCLA’s language in favor of
imposing the most expansive liability, citing the statute’s remedial
purpose.”).

121

Freshfields Bruckhaus Deringer & UNEP Finance Initiative, A
Legal Framework for the Integration of Environmental, Social andGovernance Issues into Institutional Investment (2005).

122

Gunnar Friede et al., ESG and Financial Performance: AggregatedEvidence from More than 2000 Empirical Studies, 5 J. Sustainable
Fin. & Inv. 210 (2015).

123

Mozaffar Khan, Corporate Governance, ESG, and Stock Returns
Around the World, 75 J. Sustainable Fin. & Inv. 103 (2019).

124

Brian Croce, DOL Proposal Could Chill Prospects for ESG in ERISA
Plans, Pension & Invs. (June 26, 2020), https://www.pionline.com/
regulation/dol-proposal-could-chill-prospects-esg-erisa-plans.

125

Chris Lafakis et al., Moody’s Analytics, The Economic Implicationsof Climate Change 2 (2019), https://www.moodysanalytics.com/-/
media/article/2019/economic-implications-of-climate-change.pdf.

126

At the annual general membership meeting of the Investment
Company Institute on May 2, 2019, former SEC Chair Jay Clayton
stated in his remarks, “Forty years ago, our rules said: ‘Tell us about
your plant, property, and equipment. Tell us about your sort of hard
capital asset and what they mean to your business[.]’ . . . If I am aninvestor looking at businesses today, I want to know what you aredoing with your human talent, how you are growing your humantalent, how you are accessing new talent, how you are retaining
existing talent . . . .” Thomson Reuters Tax & Accounting, Chairman
Clayton: Companies Should Provide More Disclosure on Human
Capital Management, Thomson Reuters (May 6, 2019), https://tax.
thomsonreuters.com/news/chairman-clayton-companies-shouldprovide-more-disclosure-on-human-capital-management/. In
addition, in his remarks to the SEC Investor Advisory Committee

547

on March 28, 2019, former Chair Clayton said, “Turning to humancapital, I believe that the strength of our economy and many ofour public companies is due, in significant and increasing part, tohuman capital, and for some of those companies human capitalis a mission-critical asset.” Jay Clayton, Remarks to the SEC
Investor Advisory Committee, U.S. Secs. & Exch. Comm’n (Mar. 28,2019), https://www.sec.gov/news/public-statement/clayton-remarksinvestor-advisory-committee-032819 (emphasis added).
127

Sean Collins & Kristen Sullivan, Advancing Environmental, Social,and Governance Investing, Deloitte (Feb. 20, 2020), https://www2.
deloitte.com/us/en/insights/industry/financial-services/esg-investingperformance.html (“Client demand from both retail and institutional
investors is now the top reason reported by money managers toincorporate ESG factors into investment decisions.”).

128

Id.

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

ANNEXESJURISDICTION REPORTS

Australia

BrazilCanadaChina

European Union
FranceJapan

Netherlands

South Africa
United Kingdom
United States

GLOSSARY
REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGGLOSSARYCONTENTSFOREWORDSINTRODUCTION
Defined Term

Description

2005 Freshfields Report

Freshfields Bruckhaus Deringer, A legal framework for the integration of environmental, social and governance issues into institutional investment,
produced for the Asset Management Working Group of the UNEP Financial Initiative, 2005

2020 UK Code2020 UK Stewardship Code

Amendment IDD Delegated Regulation

Commission Delegated Regulation amending Delegated Regulations (EU) 2017/2358 and (EU) 2017/2359 as regards the integration of sustainability
factors, risks and preferences into the product oversight and governance requirements for insurance undertakings and insurance distributors and into
the rules on conduct of business and investment advice for insurance-based investment products, C(2021) 2614 final

AuM

Assets under management

Black letter law

Legal standards expressed and established in legislation or judge made law, and ascertainable from printed sources

Beneficiary

A person who derives a financial benefit from asset owners’
investment activity, see Section B.1.1.4

CAPM

Capital Asset Pricing Model

CDP

CDP (formerly known as the Carbon Disclosure Project) is a global environmental impact non-profit, providing a platform, working with the CDSB, forcompanies, cities, states and regions to report information on their climate, deforestation and water security impacts.

CDSB

Climate Disclosure Standards Board

CESR

Committee of European Securities Regulators

EU Commission

European Commission

COP

UN Global Compact Communications on Progress

CRISA

Code for Responsible Investing in South Africa

CSA

Corporate Sustainability Assessment

DAI

Dutch Association of Insurers

DB

Defined Benefit

DC

Defined Contribution

ECJ

European Court of Justice

ELD/Environmental Liability Directive

Directive 2004/35/CE of the European Parliament and of the Council of 21 April 2004 on environmental liability with regard to the prevention andremedying of environmental damage, OJ L 143, 30 April 2004, 56–75

ELTIFsEuropean long-term investment funds

EMH

Efficient Markets Hypothesis

EPA

UK Environmental Protection Act 1990

ERISA

US Employee Pension Retirement Income Security Act of 1974

ESAs

The European Supervisory Authorities (EBA, EIOPA and ESMA)ETF

Exchange Traded Funds

548

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGGLOSSARYCONTENTSFOREWORDSINTRODUCTION
Defined Term

Description

EU Action Plan on Sustainable FinanceCommunication from the Commission to the European Parliament, the European Council the Council, the European Central Bank, the European
Economic and Social Committee and the Committee of the Regions, Action Plan: Financing Sustainable Growth, 8 March 2018, COM(2018) 97 final

European Green Deal

Communication from the Commission to the European Parliament, the European Council the Council, the European Central Bank, the European
Economic and Social Committee and the Committee of the Regions, The European Green Deal, 11 December 2019, COM(2019) 640 final

EuSEF

European social entrepreneurship funds

EuVECA

European venture capital funds

Fiduciary duties

See Section B.3.3.2

Fiduciary manager

Service provider who advises clients on how to invest their assets and then makes investments on behalf of the client, see Part B.1.1.3(c).

GIIN

Global Impact Investing Network

Global AuM

the world’s assets under management by institutional investors

GRI

Global Reporting Initiative

IBIP

Insurance-based investment product

IFSI

Investing for Sustainability Impact, see below

IGCC

Institutional Investor Group on Climate Change

IIRC

International Integrated Reporting Council

IMA

Investment Management AgreementIMP

The Impact Management Project

ImpactFor an explanation of the way in which this expression is used in the Report, see Part A, Box 1

Instrumental IFSIBroadly, where achieving the relevant sustainability impact goal is ‘instrumental’ in realising the investor’s financial return goals, see Part A.1, Box 3

Investing for Sustainability Impact

Any activity of an investor (using investment powers,
stewardship, policy engagement or otherwise) with theintention of achieving an assessable positive change in thesustainability impact of a third party, including a reduction
in negative sustainability impacts - see further in Part A.1.2

Investment consultant

Service provider that provides strategic advice to Asset Owners covering such matters as asset allocation and investment strategy. See Part B.1.1.3(c)Investment manager

See Section B.1.1.3(b)Investment decision maker

For IORPs, the occupational pension fund or Investment Manager(s) appointed by the occupational pension funds. For PEPP Providers, the personal
pension fund or Investment Manager(s) appointed by the personal pension fund

IORP II

Directive (EU) 2016/2341 of the European Parliament and of the Council of 14 December 2016 on the activities and supervision of institutions foroccupational retirement provision (IORPs), OJ L 354, 23 December 2016, 37–85

IORPs

Institutions for occupational retirement provision549

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGGLOSSARYCONTENTSFOREWORDSINTRODUCTIONACKNOWLEDGEMENTS

Defined Term

Description

Joint Technical Advice

Joint Committee of the European Supervisory Authorities, Joint Technical Advice on the procedures used to establish whether a PRIIP targets specificenvironmental or social objectives pursuant to Article 8 (4) of Regulation (EU) No 1286/2014 on key information documents (KID) for packaged retailand insurance-based investment products (PRIIPs), JC 2017 43, 28 July 2017

EXECUTIVE SUMMARY

Legal rules

Broadly, any legal provision (whether established in legislation or arising under judge-made law) that is intended to guide behaviour by imposing duties
or discretions or conferring powers, see Section A.2.2

MAR

Regulation (EU) No 596/2014 of the European Parliament and the European Council of 16 April 2014 on market abuse (market abuse regulation) andrepealing Directive 2003/6/EC of the European Parliament and the Council and Commission Directives 2003/124/EC, 2003/125/EC and 2004/72/EC, OJ L
173, 12 June 2014, 1–61

A. INVESTING FORSUSTAINABILITY IMPACT

Member States

Member states of the European Union

MiFID II

Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive
2002/92/EC and Directive 2011/61/EU, OJ L 173, 12 June 2014, 349–496

MiFID II Delegated Directive

Commission Delegated Directive (EU) 2017/593 of 7 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council
with regard to safeguarding of financial instruments and funds belonging to clients, product governance obligations and the rules applicable to theprovision or reception of fees, commissions or any monetary or non-monetary benefits, OJ L 87, 31 March 2017, p. 500–517

MiFID II Delegated Regulation

Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council
as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive, OJ L 87, 31
March2017, p. 1–83

ANNEXESMiFID II sustainability Delegated Directive

Commission Delegated Directive (EU) .../… of 21 April 2021 amending Delegated Directive (EU) 2017/593 as regards the integration of sustainability
factors into the product governance obligations - C(2021) 2612 final

GLOSSARYMiFID II sustainability Delegated Regulation

Commission Delegated Regulation (EU) …/... of 21 April 2021 amending Delegated Regulation (EU) 2017/565 as regards the integration of sustainability
factors, risks and preferences into certain organisational requirements and operating conditions for investment firms, C(2021) 2616 final

REFERENCES

Mutual fundSee Section B.1.1.3(a)NCP

National Contact PointNGO

Non-Governmental Organisation

Non-Financial Reporting Directive or NFR Directive

Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of nonfinancial and diversity information by certain large undertakings and groups, OJ L 330, 15 November 2014, p. 1–9

OECD Guidelines

OECD Guidelines for Multinational Enterprises

OPIM

Operating Principles for Impact Management

Overarching sustainability outcomes

See Section A.1.2.1

OutcomeFor an explanation of the way in which this expression is used in the Report, see Part A, Box 1

Passively managed funds

Funds that seek to track the performance of a given index by replicating its constituents

Pension fundSee Section B.1.1.3(a)PEPP

Pan-European Personal Pension Product

PEPP Providers

Providers of pan-European Personal Pension Product550

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGGLOSSARYCONTENTSFOREWORDSINTRODUCTION
Defined Term

Description

PEPP Regulation

Regulation (EU) 2019/1238 of the European Parliament and of the Council of 20 June 2019 on a pan-European Personal Pension Product (PEPP), OJ L 198,
25 July 2019, 1–63

PPP

‘Prudent person’ principle

PRIIPs Regulation

Regulation (EU) No 1286/2014 of the European Parliament and of the Council of 26 November 2014 on key information documents for packaged retailand insurance-based investment products, OJ L 352, 9. December 2014, 1–23

PEPP Regulatory Technical Standards

Commission Delegated Regulation (EU) 2021/473 of 18 December 2020 supplementing Regulation (EU) 2019/1238 of the European Parliament and of theCouncil with regard to regulatory technical standards specifying the requirements on information documents, on the costs and fees included in thecost cap and on risk-mitigation techniques for the pan-European Personal Pension Product, OJ L/99, 22 March 2021, 1-33

RTS

Regulatory Technical Standards

SASB

Sustainability Accounting Standards Board in the US

SFDR/Disclosure Regulation

Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial
services sector, OJ L 317, 9 December 2019, 1–16

SIC

Sustainable Investing Code

Solvency II

Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance
and Reinsurance, OJ L 335, 17 December 2009, 1–155

Solvency II Delegated Regulation

Commission Delegated Regulation (EU) 2015/35 of 10 October 2014 supplementing Directive 2009/138/EC of the European Parliament and of the Council
on the taking up and pursuit of the business of Insurance and Reinsurance, OJ L 12, 17 January 2015, 1–797

Amendment Solvency II Delegated Regulation

Commission Delegated Regulation amending Delegated Regulation (EU) 2015/35 as regards the integration of sustainability risks in the governance of
insurance and reinsurance undertakings, C(2021) 2628 final, 21 April 2021

SRD

Directive 2007/36/EC of the European Parliament and of the Council of 11 July 2007 on the exercise of certain rights of shareholders in listedcompanies, OJ L 184, 14 July 2007, 17–24

SRD II

Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement oflong-term shareholder engagement, OJ L 132, 20 May 2017, 1–25

Sustainability factors

See Section A, Box 2

Sustainability impact

See Section A.1.2

Sustainability impact goals

See Section A.1.2

Systemic risk

See Part A.1, Box 4

Taxonomy Regulation

Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable
investment, and amending Regulation (EU) 2019/2088, OJ L 198, 22 June 2020, OJ L 198, 22 June 2020, p. 13–43

TCFD

Task-Force on Climate-related Financial Disclosures

Transparency Directive

Directive 2004/109/EC of the European Parliament and of the Council of 15 December 2004 on the harmonisation of transparency requirements inrelation to information about issuers whose securities are admitted to trading on a regulated market and amending Directive 2001/34/EC, OJ L 390, 31
December 2004, 38–57

551

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGGLOSSARYCONTENTSFOREWORDSINTRODUCTION
Defined Term

Description

UCITS

Undertakings for collective investment in transferable securities

UCITS Delegated Directive

Commission Directive 2010/43/EU of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and the Council as regards
organisational requirements, conflicts of interest, conduct of business, risk management and content of the agreement between a depositary and amanagement company, OJ L 176, 10 July 2010, 42–6

UCITS Directive

Directive 2009/65/EC of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective
investment in transferable securities, OJ L 302, 17 November 2009, 32–96

Ultimate Ends IFSIBroadly, where achieving a sustainability impact goalis pursued alongside the investor’s financial return goals, but not as a means to achieving them,see Part A, Box 3

UNCTAD

United Nations Conference on Trade and Development

UNFCC

UN Framework Convention on Climate Change

WBAWorld Benchmarking Alliance

ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY

REFERENCES

552

Freshfields Bruckhaus Deringer LLPA LEGAL FRAMEWORK FOR IMPACT: SUSTAINABILITY IMPACT IN INVESTOR DECISION-MAKINGREFERENCESCONTENTSFOREWORDSINTRODUCTION

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B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
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B. THE EXTENT TO WHICH
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ANNEXESGLOSSARY
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Net Zero Investment Framework: Implementation
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ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
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Investment Consultants Sustainability Working
Group, Guide for assessing the climate competency of
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MacLaughlin, D. and Massa, A., ‘The Hidden
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Joint Committee of the European Supervisory
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Mahmoud, O. and Meyer, J, Social Responsibility
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ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

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B. THE EXTENT TO WHICH
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Base, 2015.

C. AREAS FOR LEGAL REFORM

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January 2019.
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Morgan Stanley Institute for Sustainable
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Natixis Investment Managers, Trust, Transparency
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Natixis Investment Managers, Retirement Reality
Check: A Generational Look at Defined Contribution
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Natixis Investment Managers, Looking for the Best ofBoth Worlds, 2019.
Netherlands Authority for Consumers and Markets,
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Nuveen, Fifth Annual Responsible Investing Survey, 2019.

OECD , Pension Markets in Focus, 2019.
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Practices, Policies, Procedures and Disclosure in AssetManagement, Consultation Report, CR 01/21, 2021.
OECD , Social Impact Investment 2019: The Impact
Imperative for Sustainable Development, 2019.

ANNEXESGLOSSARY
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ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM
ANNEXESGLOSSARY
REFERENCES

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ACKNOWLEDGEMENTSEXECUTIVE SUMMARY

A. INVESTING FORSUSTAINABILITY IMPACT

B. THE EXTENT TO WHICH
THE LAW REQUIRES ORPERMITS IFSIC. AREAS FOR LEGAL REFORM

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ANNEXESUS Trust Bank of America Private WealthManagement, Insights on Wealth and Worth, 2018.

GLOSSARY

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