• The report is the next layer building on the Freshfields report of 2005 and the Fiduciary Duty for the 21st Century project in charting out the evolving legal landscape behind responsible finance
  • Policy makers in the markets they surveyed, as well as in emerging markets for ESG like many Islamic markets, may be called upon to give clearer guidance, such as about investor participation in collective efforts on stewardship activities in support of positive impact

A new report from PRI, UNEP FI and Generation Foundation, A Legal Framework for Impact, is aimed at helping asset owners and managers to understand their obligations and opportunities as they go beyond just integrating ESG data. The report discusses how current laws support or impede asset managers and owners, focusing on intentional efforts to achieve positive impacts. In general it outlines several scenarios where consideration of impact is likely to become commonplace, or already is.

This latest PRI and UNEP FI report studying the legal basis for responsible investment follows on from the 2005 Freshfields Report commissioned by a UNEP FI Asset Management Working Group on the permissibility for institutional investors of integrating ESG. More recently, it was followed by PRI, UNEP FI and Generation Foundation jointly releasing the Fiduciary Duty in the 21st Century report. This report outlined how ESG was consistent with fiduciary duty in many situations as well as how ESG may be required under contemporary understanding of fiduciary duty because of the financial materiality of many ESG issues for companies.

The latest report from PRI, UNEP FI and Generation Foundation extends the analysis into the area of ‘investing for sustainability impact’, which the report refers to as ‘IFSI’. While previous reports tackled the legal understanding around ESG integration, this report considers positive impact. More specifically, it outlines the role for “any activities that involve an investor intentionally attempting (through the activities it finances or otherwise) to influence the behaviour of investee enterprises and other third parties in assessable ways that can help to achieve overarching sustainability outcomes”.

This concept aligns with but doesn’t entirely overlap with the concept of impact investing, which falls into a category of “ultimate ends IFSI” by focusing on pursuing sustainability impact alongside financial returns. In between ESG integration and ‘ultimate ends IFSI’ classifications, the report refers to ‘instrumental IFSI’, which it defines as sustainability impact as relevant to long-term financial objectives.

One take-away from the report is that there remains a wide variability in what asset owners and managers are required to consider in terms of impact. Targeting impact that enables achievement of financial objectives may be allowable, and assessing impact actually achieved in comparison with intended impact may be required depending on regulations around investment product labeling.

The bottom line is that there remain wide gaps in giving a definite legal answer to what sustainability impact focus is allowed and what is required that is consistent internationally. Some of the gaps that exist today include asset owners not having clear enough benchmarks for what their beneficiary preferences are or are likely to be. There are still not enough data to understand at an investment strategy level what the link is where achieving a sustainability impact is instrumental in achieving specific financial impacts.

Even so, there are more situations where there is growing clarity from regulators. The report gives as an example “a mutual fund established with the aim of bringing about a particular type of sustainability impact”. As this newsletter outlined last week, regulators have begun to step up the rigor of their regulation on these types of funds to ensure investors in products that are labeled as ‘ESG’ or ‘sustainability’ are getting what they expect.

Guiding principles for UK fund managers from the Financial Conduct Authority and the European Sustainable Finance Disclosure Regulation (SFDR) for managers of European funds, for example, separate the market between funds using ESG integration only for financial reasons (not able to use ‘ESG’ or ‘sustainability’ labels) and those explicitly targeting and measuring impact (able to use these labels).

Many of these regulatory efforts are in developed markets, but the issues covered in the report will have international relevance. Many funds offered in emerging and developing markets, including Islamic markets, are subject to the effect of regulations describe above. Even if these funds — which are among the financial products created by financial institutions valued at over $3 trillion that may be affected by SFDR — are not subject to regulation within their home markets, they will still be affected by other regulators’ policies about sustainability labeling and the impact assessments they undertake anywhere they are offered.

As responsible investment expands, policymakers and regulators have to stay on top of these important issues and work to provide clearer guidance. The report outlines a long list of possible policies that could help add clarity, such as supporting development of market-based infrastructure to help asset owners and managers engage on sustainability impact, including through collaborative initiatives. Policy makers may also need to provide clarification about whether such initiatives will be viewed as part of investors’ work to fulfil their duty to beneficiaries, unless evidence to the contrary is found, or if the burden is on the participating asset owners and managers to prove it themselves.

The pace of responsible finance market development is evolving rapidly, including the development of how ESG integration and investing for sustainability are accepted or required by law or permitted within the bounds of market norms. Unlike in the past, when reports on the legal implications of ESG and sustainability took years to surface in widespread actions or regulation, there are already many disclosure requirements coming into force which will be reinforced by this report. As we outlined last week, asset managers and owners in Islamic markets that are starting to integrate ESG need also to prepare for how to demonstrate their sustainability impact either as an instrument towards financial objectives or in working towards a sustainability objective defined on its own terms.

Republished from the RFI Foundation’s weekly newsletter. Subscribe for free here!

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Promoting adoption of responsible finance in Islamic markets & Islamic finance. CEO @RFIFoundation.

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Blake Goud

Blake Goud

Promoting adoption of responsible finance in Islamic markets & Islamic finance. CEO @RFIFoundation.

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