What does investment stewardship mean in the era of climate change and the Global Goals?

by Carol Adams

Main points:

  • The UN SDGs provide a useful framework for investors to consider social and environmental risks
  • The UK Financial Reporting Council’s (FRC) revised Stewardship Code recognises that climate change poses risk to investment beneficiaries’ returns
  • Responses to the Australian Senate Inquiry on the SDGs emphasised the role of investors

Investment stewardship, the allocation and management of capital, requires consideration of climate change and other sustainable development risks.  Once considered only as an ethical issue, this has now been recognised as a requirement for asset owners  and managers to fulfilling fiduciary duty.

Signatories to the revised UK Financial Reporting Council’s (FRC) Stewardship Code which is out for consultation will have to say how they monitor ESG issues, including climate change, that may impact the value of assets held over the investment horizon of their beneficiaries (for asset owners) or clients (for asset managers). In the case of young pension fund members this could be over fifty years and is increasing as we live longer.

In the proposed revised definition of investment stewardship long term value for society is seen as linked to increasing the value of assets for beneficiaries.  Investment stewardship is:

…the responsible allocation and management of capital across the institutional investment community to create sustainable value for beneficiaries, the economy and society.

This follows a 2017 report by the Law Commission arguing that there was ‘no impediment’ to pension fund trustees taking account of ESG issues which may be financially material and recommending that the government clarify that trustees have a duty to consider climate change risk.  Responses by Chairs of Trustee Boards of the largest UK pension funds to the Green Finance Inquiry indicated that many were not taking this duty seriously enough and yet the UK government rejected the Inquiry’s proposal to make the TCFD recommendations mandatory. The government argued:

For large institutional investors to be able to make meaningful disclosures in line with TCFD, there first needs to be widespread reporting by firms.

The problem is that unless investors are asking for information on climate change risks, many companies will not provide it.

Fortunately for anyone with a pension fund in the UK, the Financial Reporting Council (FRC) has stepped in.  Although out for consultation and therefore not final, the explicit reference to ESG in the draft revised code is unlikely to change – appetite for its inclusion was tested in a few questions tagged on the FRC’s Corporate Governance Code consultation last year and received a positive response.

Research has shown that ESG risks and opportunities influence value creation and need to be considered in developing corporate strategy (see Figure 1 in Adams, 2017).  Companies and investors have been slow to respond, but this is changing.  A number of investors, their representative bodies and stakeholders giving evidence to the Australian Senate Inquiry on the SDGs last year gave examples of investor initiatives concerning the SDGs.  When I gave evidence to the Inquiry in a public hearing Senator Gallacher, noting that he was the chair of an investment committee and a director of a fund, asked:

But how do you get over the sole purpose test?

He specifically referred to ethical issues such as tobacco and gambling which are different from sustainable development risks such as climate change, water and energy security.  I responded:

—if you take a young person just starting in the workforce, who could be investing in a pension fund for fifty years, to pass the sole purpose test I think a fund has to be considering climate change and other sustainable development risks. If it’s not, it runs the risk of actually not applying that test.

So the FRC, which wrote the world’s first Stewardship Code in 2010, has shown leadership once again.  But I’d like to see them take the opportunity to require that the ‘Activities and Outcomes Reports’ of signatories to the Code discuss:

  • the process by which asset owners/ managers are engaging with companies in which they invest on: material ESG risks and opportunities; and, contributions to, or negative impacts on achievement of the SDGs.
  • how they plan to improve the effectiveness of their stewardship in the future in order to ensure continued adaptation of their investment approach to changing circumstances – particularly with regard to social and environmental risks.

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