ESG and Fiduciary Responsibility: Europe vs US
In a recent article for Pension Funds Online, SECOR’s Andrew Bang, shares his thoughts on the consistency of global ESG pension investing standards.
Institutional, private, and public capital globally have largely contributed to the surge in ESG related investments; currently estimated to be approximately $35 trillion and growing. This phenomenon has led to increased interest and scrutiny of ESG investing. While the EU is making collaborative efforts to harmonise ESG regulations, the US has not yet proceeded in that direction. The lack of consistent and global ESG pension investing standards has resulted in a divergence between Europe and the US.
Although the US & EU have similar fiduciary duty guiding principles, they have arrived at different conclusions on the suitability of incorporating ESG in pension management. Multinational corporations and global pensions must answer to multiple, and at times competing, regulatory jurisdictions and stakeholder interests, creating a growing dilemma of how to address inconsistencies and conflicting views.
UK and EU Regulatory Regime
The UK and the EU maintain a strong conviction to their ESG macro beliefs. Their ESG regulatory requirements and reporting are well established, and typically legally mandated. For pensions, the IORP II (Institute for Occupational Retirement Provision) has established the overarching ESG requirements for member country retirement plans and refer to ESG as an important component to investment policy and risk management systems. Regulations, such as the SFDR (Sustainable Finance Disclosure Regulation), set mandatory disclosure rules for corporations and investment products, and seeks to identify sustainability impacts and risks. The full extent of EU regulations is much more comprehensive, and member countries’ laws may exceed the requirements set forth by the EU.
The UK implemented specific changes to environmental regulations for aligning businesses with sustainable business practices. The UK became the first G20 country to make TCFD (Task Force on Climate-Related Financial Disclosures) recommendations on climate related risks and disclosures mandatory. Voluntary initiatives such as the UK Stewardship Code (2020) seek to set stewardship standards in capital management including sustainable benefits for the environment and society. Most ESG legislation is primarily aimed at corporations and investment managers, but not specifically for pension plans. These rules foster ESG macro beliefs, transparency and seeks to avoid potential “greenwashing” of investment products, but not specifically designed for pension funds. Pension funds are often bound by these laws even though the plans were not principally targeted. Altogether, this makes compliance in a substantive manner somewhat of a struggle at times.
US Regulatory Regime
Currently, the US lacks formal federal level laws and regulations that specifically mandates or fosters ESG macro beliefs and sustainable investing leaving ESG investing open to interpretation. In general, ESG investing or related activity has been a result of voluntary demand from either corporate and financial owners or indirect influence from global ESG/sustainable initiatives. The primary governance regime for corporate and private pension in the U.S. is the US Department of Labor’s (DOL) ERISA (Employee Retirement Income Security Act, 1974). The latest update takes a principles-based approach stating that consideration of ESG factors is explicitly permitted, but principles of prudence and loyalty should be the focus.
Public pension plans established or overseen by US state entities however are not subject to ERISA’s requirements but are governed by state and local laws. The lack of a federal, nationwide ESG policy has resulted in a wide array of legal interpretations, contributing to complexity and uncertainty. Unfortunately, ESG considerations at the state-level appear to have been highly politicised and recent November election results may impact state or local pension plans’ interpretation of ESG.
Rationales for ESG considerations are typically interpretations of the prudent persons rule to act in the best interest of beneficiaries. This allows some justification and interpretation of whether ESG investing is prudent and in the beneficiary’s best interests.
Addressing This Dilemma
We believe risk and return considerations are the paramount objective and that ESG considerations are an indispensable component of optimal investment decisions. This means that:
- Investors and managers should focus on an optimal risk/return profile, paying particular attention to investment risk factors such as climate change impact and financial outcome; and
- a rigorous investment process should be employed to fully vet investments with clear investment rationale in particular to ESG labelled products for “greenwashing”
This focus, we think, will mitigate risks during an evolving and shifting ESG environment and allow plans to be adaptable to future regulations and changes that may arise, irrespective of the jurisdiction in which they arise.
 Hazel Bradford, “Sustainable Investment Assets Hit $35trillion, 36% of all Managed Assets” Pensions and Investments. Jul 19, 2021.