Fiduciary responsibility of money managers in the age of climate change

Fiduciary duties underpin the modern economy where the principal (beneficiary) relies on the agent (manager) to act in the best interest of the former instead of their own. In modern money management, beneficiaries (savers) hand over their savings to the agent (money managers) to manage the money with a clear investment objective - maximising return within the risk limit. With climate change now a recognised material risk and opportunity, regulators need to ensure money managers do not neglect or ignore it to protect the interests of savers. This is where a moral or fiduciary duty of the asset owner or investor comes into play.

The best interest of clients

The fiduciary duty of the money manager has evolved over decades, adjusting to changing market conditions and practices, policies, regulations, etc. The rapid development of sustainability and climate change warrants another adjustment.

Inaction on climate change comes with the assumption that action would not affect the company’s  profitability. However, evidence suggests a positive relationship between sustainability and the financial performance of corporations that grows stronger in the long term.

Researchers agree that sustainability does very well during crises when beneficiaries need money managers most. The liability duration of certain money managers, such as pension funds and insurance companies, is long. They should be more concerned about the long-term performance of their funds instead of short-term underperformance. Hence, managers become responsible for the failure to manage climate change risks.

How can it be performed?

Funds can disclose how they have integrated climate into their investment practice, which will encourage them to adopt sustainable investment practices.

Here is where the Stewardship Code becomes important. Within the fiduciary duty, the Stewardship Code allows money managers to interact with investee companies to create long-term investment value. Money managers can guide companies’ management when on the board and use proxy votes to encourage certain management decisions.

Fund managers can address climate change and sustainability issues during Annual General Meetings (AGMs), hold companies accountable, push for better sustainability practices, and integrate climate change in strategic planning and risk management. Whether following a shareholder primacy theory or stakeholder theory, both dictate the social (or environmental) values that need consideration.

In India, under the Company’s Act 2013, many interpretations have been analysed to broadly imply that fund managers’ fiduciary role is pluralistic.  Within their  fiduciary duty boundary they can nudge companies to disclose  climate-related information that is beyond regulatory guidelines that can help them to make a better decision.

This active engagement can help improve corporate disclosures. Further, an added advantage would be the spillover effect of a larger capital allocation into climate mitigation and adaptation businesses, increasing the resilience of funds managers manage.

Recent regulatory push

Over the past few years, the Securities and Exchange Board of India (SEBI) has taken several positive measures to ensure disclosure, especially from an ESG perspective. It can complement these measures by forming guidelines for the fiduciary duty of money managers (e.g., mutual funds, pension funds,  insurance companies, etc). The Financial Stability and Development Council (FSDC) approved a unified stewardship code in consultation with SEBI, the Insurance Regulatory Development Authority (IRDA) and the Pension Fund Regulatory Development Authority (PFRDA).

The Stewardship Code’s incorporation of ESG compliance norms is a great first step. This needs further strengthening to ensure adherence to them in practice, with action on non-compliance.

In addition, there is a need for greater resource allocation to help regulators focus on the compliance of money managers if the integration of sustainability is mandatory in their jurisdiction.

What more can regulators do

First, PFRDA, SEBI and IRDA can ask their regulated entities to disclose how sustainability and climate change are integrated for stock or bond picking and portfolio construction. The regulators also need to complement it with clarity around defining sustainability, climate risks, ESG investing, etc. For example, the International Organization of Securities Commissions’ recent guidelines sets clear expectations for money managers. They must develop and implement practices, policies and procedures relating to material sustainability-related risks and opportunities. Moreover, they must disclose how they have integrated sustainability into their investment decision-making processes. The disclosure should cover four key areas: governance, strategy, risk management, and metrics and targets, as recommended by the Task Force on Climate-related Financial Disclosures (TCFD) and adopted by International Financial Reporting Standards (IFRS) later (IFRS S1 and IFRS S2). 

Second, institutional investors must disclose how they follow the Stewardship Code within their fiduciary duty through a clear, consistent disclosure methodology. Following the Reserve Bank of India’s (RBI) leadership in acknowledging p climate-related financial risks, other financial regulators should ask their regulated entities to consider these risks. This may also allow capital reallocation into sustainable activities, increasing market resilience and completing the cycle of an environmentally and climatically sustainable financial system. Money managers can also use sustainability and climate change as lenses to push companies to transition to more sustainable business practices. Additionally, the code that already outlines guidelines for investors to create a comprehensive policy that includes monitoring and reporting mechanisms should be broadened to include sustainability and climate change. Disclosure on both the above-given fronts needs third-party assurance to guide the efficacy.

Lastly, there are opportunities for PFRDA, SEBI and IRDA to enhance the understanding of climate change risks and opportunities among their executives and board members or trusts to regulate their regulated entities better. They can refine their Stewardship Code, particularly in line with the evolving regulatory developments related to sustainability and climate change risks like Business Responsibility and Sustainability Reporting (BRSR) disclosure.

The changing financial landscape needs all stakeholders to be more active in considering climate risks within their portfolios. A green transition of the economic system in any country needs a transition of the financial system, which starts with the duty and standard of care, all encompassed under a strong fiduciary duty.

Views are personal and do not represent that of the authors’ employers.

This article was first published in ETEnergyWorld.