Jau Loong Chow

The anti-ESG (environment, social and governance) movement, traditionally associated with “anti-woke” right-wing politicians and business leaders, gained prominence in Europe when they alleged that European companies were suffering financially as a consequence of not focusing on maximising returns.[1] Amidst geoeconomic uncertainty and challenges, the UK administration openly stated that it is contemplating rolling back some of its key climate targets[2]. In contrast, a group of Vanguard investors took a different stance by expressing serious concerns and criticising Vanguard’s failure to account for the risk of climate change into their portfolio[3]. Central to both sets of arguments is the concept of fiduciary duty, seen as a legal and ethical obligation to act in the best interests of their clients. The anti-ESG movement argues focusing on ESG matters and social agendas unrelated to the clients’ long-term financial interests is a breach of fiduciary duty as they should focus on profit maximisation[4]. On the other hand, socially and environmentally conscious investors, seen in the case of investors’ letter to Vanguard, believes that investors are violating their duty of care if they do not use their voice and influence to drive positive climate action[5]. As the debate between pro and anti-ESG sentiments intensifies, questions about the interpretation and application of fiduciary duty become more prominent. To what extent should investment managers consider ESG factors while upholding their fiduciary duty of prudence and loyalty? Has the dial shifted? Yes, but not without some apprehension Fiduciary duty, at its core, refers to the obligation that individuals or entities bear when entrusted with managing others’ money or asset, which involves acting in the best interests of the beneficiaries. According to the United Nations Environment Programme Finance Initiative (UNEPFI), fiduciary duty comprises of two components: i) loyalty - where fiduciaries should act in good faith in the interests of their beneficiaries and ii) prudence - where fiduciaries exercise sound judgement and diligence in managing assets.[6] The UN Principles for Responsible Investment states that the fiduciary duty of investors should incorporate all value drivers, including ESG in their investment decision making.[7]Nevertheless, several investors highlight fiduciary responsibility as a limiting factor in their participation in such practices, as they are concerned that incorporating ESG factors could compromise their ability to maximise their returns for their clients.[8] In a highly competitive market, the fear of losing a competitive advantage against peers becomes a compelling reason for hesitancy. In our research report, Investing for a better world: navigating 6 paradoxes, we identify three key messages that shed light on how this tension is perceived and navigated by investors in the current landscape.Rule number one: Sustainable investments need to be financially-materialInvestment managers often face the challenge of ensuring both profitability and societal impact. The fiduciary duty of loyalty underscores the imperative for institutional investors to act in a manner that benefits their clients financially while acknowledging such benefits may extend beyond immediate financial returns. Consequently, a fundamental guiding principle for many investment managers is to ensure sustainable investing make commercial sense and be rooted in financial materiality. Rather than exclusively focusing on groundbreaking technologies, risk mitigation and identification of new opportunities that align with sustainable practices, and integrating them into traditional investment frameworks.[9] There are nuanced variances in fiduciary duty across jurisdictions The complexity of the matter is exacerbated by the fact that many regulatory regimes afford a degree of discretion to integrate ESG considerations, owing to differences in legal systems and cultural contexts.[10] In numerous jurisdictions ESG rules and guidelines can be vague. Operating under the premise of “prudence”, some jurisdictions insist investment managers should only consider financial interests. In contrast, other jurisdictions allow flexibility for investment managers to consider non-factors in parallel with financial factors. [11] A notable distinction is the definition of fiduciary duty between common law and civil law jurisdictions. In common law jurisdictions, such as Australia, the UK and US, fiduciary duties are key constraints on the discretion of investment decision, although these rules could be reinterpreted over time. In civil law jurisdictions like Germany and Japan, any obligations equivalent to “fiduciary duties” are explicitly outlined in statutory provisions that regulate the conduct of investment decision-makers For instance, in the US, the Employeee Retirement Income Security Act of 1974 (ERISA) imposes a strict duty of loyalty, requiring fiduciaries to act solely in the interest of beneficiaries for the exclusive purpose of providing financial benefits to them (a new rule which permits ERISA fiduciaries to consider ESG factors was released, although this has received backlash from opponents, who felt that it contravenes the conventional fiduciary duty of maximising financial returns for fiduciaries).[12] In Germany, pension funds may integrate in ESG factors if they inform their beneficiaries in writing if and how it takes ethical, social and ecological aspects into account in its investment policies.[13] Fiduciary duty goes beyond financial returns There is also a common myth that sustainable investing, or impact investing—investments with the intent to generate positive, measurable social and environmental impact alongside a financial return[14] —is incompatible with the fiduciary duties of private and public fund managers, and could have detrimental impact on the financial returns generated. Contrary to this misconception, there is growing realisation by many investors that sustainable investing and the pursuit of risk-adjusted returns are not mutually exclusive. This is evident in the increasing number of institutional investors that incorporate social and environmental factors into their investment framework, recognising the long-term value they add to their assets. One example is the expectations outlined by a commission set up the Norwegian government on Norges Bank Investment Management (NBIM), highlighting the paramount importance of NBIM to pursue good financial returns and responsible investment. This dual approach is deemed essential for maintain the fund’s legitimacy, both nationally and internationally.[15] Similarly, Khazanah, Malaysia’s sovereign wealth fund and a signatory to the Principles for Responsible Investment, in their governance and accountability framework, states that they would incorporate ESG issues into their decision-making processes and ownership policies that is consistent with their fiduciary duties.[16] ConclusionAmidst an ongoing anti-ESG movement, the investment industry remains unfazed and undeterred to double down their efforts in sustainable investments. A 2022 Cambridge Associates survey found that there was significant uptick on engagements in sustainable and impact investing among asset owners and asset managers, with an overwhelming proportion of respondents expressing their intentions to further increase their allocation to sustainable and impacting investing over the next five years.[17] Simultaneously, regulators are intensifying their efforts to impose more ESG disclosure and requirements on the industry. For instance, the Sustainable Finance Disclosure Disclosures Regulation Level 1 and 2 have gone into force in 2023, where financial institutions are accountable to disclose to reduce adverse sustainability impacts and greenwashing.[18] In Singapore, the Monetary Authority of Singapore published the country’s Sustainable Finance taxonomy, aimed at promoting the development of an environmentally sustainable economy for Singapore and ASEAN.[19] Additionally, the emergence of stewardship codes, with growing emphasis for investors to actively engage with investee companies on ESG issues,[20] collectively reflect a noticeable trend towards aligning fiduciary duty with societal responsibilities. While interpretations of fiduciary duty may continue to persist and vary, the overall trend signals a more encompassing view of the fiduciary’s obligations of institutional investors, and how the industry collectively is shaping a more environmentally and socially responsible future. As the investment landscape and expectations of beneficiaries continue to evolve, finding innovative ways (while ensuring profitability) to integrate sustainable practices within fiduciary duty will be essential for investors seeking to navigate this intricate terrain successfully.[1] https://www.politico.com/newsletters/the-long-game/2023/10/31/brits-barnstormed-by-esg-politics-mate-00124453[2] https://www.politico.com/newsletters/the-long-game/2023/10/31/brits-barnstormed-by-esg-politics-mate-00124453 [3] https://vanguard-sos.com/wp-content/uploads/2023/03/Vanguard-Fiduciary-Letter-March-2023.pdf [4] https://jacobin.com/2023/08/vivek-ramaswamy-strive-pensions-ethics-esg-leo [5] https://vanguard-sos.com/wp-content/uploads/2023/03/Vanguard-Fiduciary-Letter-March-2023.pdf [6] https://www.unepfi.org/fileadmin/documents/fiduciary_duty_21st_century.pdf [7] https://www.unpri.org/policy/fiduciary-duty#:~:text=Fiduciary%20duty%20exists%20to%20ensure,factors%2C%20in%20investment%20decision%20making. [8] https://www.unepfi.org/fileadmin/documents/fiduciary_duty_21st_century.pdf [9] https://www.businesstimes.com.sg/companies-markets/sustainable-financing-must-make-commercial-sense-investors-market-players-say [10] https://www.iisd.org/system/files/publications/fiduciary_duties_en.pdf [11] https://businesslawreview.uchicago.edu/online-archive/trouble-tibble-environmental-social-and-governance-esg-and-fiduciary-duty [12] https://fedsoc.org/fedsoc-review/the-30-year-history-of-diluting-erisa-s-fiduciary-duty#:~:text=Under%20the%20Employee%20Retirement%20Income,providing%20financial%20benefits%20to%20them. [13] https://www.iisd.org/system/files/publications/fiduciary_duties_en.pdf [14] https://thegiin.org/impact-investing/ [15] https://www.nbim.no/en/publications/submissions-to-ministry/2023/the-fund-in-a-changing-world--consultation-response/#:~:text=The%20commission%20writes%20that%20good,what%20the%20fund%20can%20achieve. [16] https://www.khazanah.com.my/media/uploads/2020/06/Statement_of_Compliance.pdf [17] https://www.cambridgeassociates.com/en-as/press-releases/cambridge-associates-survey-finds-institutional-engagement-in-sustainable-investing-increased-by-over-80-since-2018/ [18] https://www.sgvoice.net/policy/19306/what-new-sfdr-rules-will-be-implemented-in-january-2023/ [19] https://www.mas.gov.sg/-/media/mas-media-library/development/sustainable-finance/singaporeasia-taxonomy-dec-2023.pdf [20] https://www.moneymatters.co.nz/blog-feed/the-rise-of-stewardship

The global investment industry has undergone a significant shift. The acceleration of the momentum of sustainability investing has made it imperative for investors to integrate environmental, social and governance (ESG) factors into their investment processes. Complexities and challenges in ESG investingIn the last decade, ESG has expanded in scope and is used in myriad ways to suit the needs and expectations of multiple stakeholders. In some cases, this integration has led to greenwashing. In Asia, however, ESG adoption remains in its early stages. In 2016, Asia (ex-Japan) accounted for only 0.8% of global ESG Investing assets. Some of the main reasons for the slow adoption include: Fragmentation of data and disclosureLike many of their western peers, investors in Asia view the scarcity of comparable and historical data as barriers to ESG integration. For instance, a lack of high-quality standardised emissions data has been a hurdle for capital markets in Asia to transition to lower carbon economies. Asia’s differing levels of regulations and transparency in a highly heterogeneous region means the fragmentation challenge is more pronounced. Without a supranational governmental body like the EU, local industry standard setters are introducing regulations at different paces due to the nuances and maturity of their ESG markets. The lack of coordination in ESG disclosure requirements creates further fragmentation of data and leads to questions over the consistency of the ESG ratings. Such data gaps make it hard for investors to assess ESG investment risks and opportunities. Knowledge gaps in ESG The industry also faces a lack of ESG professionals who specialise in sustainable investments. This situation is acute in Asia, which has seen exponential growth in sustainable and green investing. Financial hubs in Singapore and Hong Kong have raised the ESG bar for listed companies in their markets. Demand for ESG talent and expertise has outstripped the supply, leading to a talent crunch. This intensifies the demand-supply mismatch of the industry – asset managers providing generic information to their clients rather than delivering the necessary data that the latter are looking for that best reflects their interests and needs. The mindset of Asian investorsIn Asia, investors still tend to prioritise profits because the benefits of ESG integration are less apparent in the short term compared to traditional financial fundamentals. The integration of ESG information into the investment process is often done on a case-by-case basis, and the approach is fragmented.Many private investors in Asia have yet to incorporate ESG investments into their portfolios, preferring to separate investment performance and social impact. Corporate governance factors are still seen as the most integrated, at least among listed companies, because of their potential impact on share prices. Comparatively, the culture to incorporate environmental and social factors still needs to be developed. The silver liningDespite the less mature ESG environment and the ESG challenges facing Asia, ESG investing in the region has seen progress in part, propelled by regulators, governments and large businesses. RegulationsGlobally, there is an effort to create converging and harmonising standards that can be interoperable across various jurisdictions, such as the International Sustainability Standards Board (ISSB), to help strengthen and standardise the practice of non-financial reporting to fulfil investor demand. On the regional level, as part of The Roadmap for ASEAN Sustainable Capital Markets, ASEAN has established its sustainability taxonomy and has published its Sustainable and Responsible Fund Standards to enhance better transparency and promote greater integration and connectivity.Separately, the Monetary Authority of Singapore (MAS) has taken a proactive role in developing global baseline sustainability reporting standards by participating in international institutions such as the International Organisation of Securities Commissions (IOSCO). It has also outlined clearer disclosure requirements to institutional investors by publishing a circular on new disclosures and reporting guidelines for retail ESG funds in Singapore. Innovation and technologyWhile Asian businesses embrace the ESG agenda, there is considerable scope for companies to scale green technologies to enhance climate sustainability in the region. As the agri-food sector expands, companies are leveraging IoT, satellite imagery and integrated farming systems to capture critical data to help improve the quality of crops and sustainable production practices. These data will help investment funds and banks better assess the environmental impact of their investments and achieve long-term returns while meeting the needs of the world’s growing population. In addition, technology can also help better sieve out important ESG data and streamline the reporting process. The Investment Management Association of Singapore has developed a Digital Accelerator Programme, which provides a platform for fund managers to tap into fintech to solve problems they face in the asset management industry. MAS and SGX have also launched an ESGenome Disclosure Portal to streamline ESG data and help companies make ESG disclosures more efficiently. This enables investors to access and compare ESG data to make better-informed investment decisions. Responsible investment stewardship While Asia explores pathways and capabilities to enable ESG integration comparable to more advanced economies, the absence of formalised standards and tools should not be a hurdle. The increase in investor demand and regulators’ push for ESG means that it is a matter of time before asset and wealth management firms need to align their broader ESG strategy and boardroom agenda to ensure the adoption of the Principles for Responsible Investment (UNPRI) and commitment to the Sustainability Development Goals. Investment managers can already add value through responsible investment stewardship – the exercising of responsible allocation, management and oversight of capital, through active ownership and engagement, to create and preserve enterprise value within portfolio companies, and improve long-term risk-adjusted returns for clients and beneficiaries. Introduced as a ‘soft law’ in many jurisdictions, stewardship codes take the form of principles to guide institutional investors in reporting stewardship practices. In most jurisdictions, investors are required to discharge their stewardship responsibilities in alignment with their ESG integration efforts. Japan has emerged as the frontrunner of ESG in Asia, given that it is the first Asian market to establish a stewardship code. The Government Pension Investment Fund, the world’s largest pension fund, is a signatory of the UNPRI and has pledged significant allocation in ESG funds, creating a momentum shift towards ESG integration in Japan and Asia. In Singapore, the Singapore Stewardship Principles for Responsible Investors (SSP) was revised last year to consider evolving investment stewardship developments. Signatories are strongly advised to showcase their stewardship activities and the outcomes achieved annually to the Secretariat. Case study submissions demonstrating stewardship efforts in line with the principles are published on the SSP website. The Secretariat is currently accepting case study submissions for the year 2023. (Click here to find out more) Conclusion Importantly, regardless of standards, regulations and disclosures, the investment industry needs steward leadership -- the genuine desire and persistence to create a better future. Steward investors lead in demonstrating how they can drive long-term returns by positively impacting the economy, society, and environment. Asia has seen a boom in family offices and private equity firms, and they can take the lead in sustainability to help portfolio companies in their ESG journeys. With the rise of Asia’s affluent investor base, many of whom are millennial and Gen Z investors, the region is gradually witnessing a populace that is more socially and environmentally aware and more inclined to invest along the lines of ESG. The call for social responsibility and collective action is growing to develop clearer ESG standards and nurture sufficient investment talent that embraces good investment stewardship practices. Amid the growing demands for ESG integration, a holistic approach that is qualitative and quantitative is required. At Stewardship Asia Centre, we believe that any rule-based framework must be underpinned by steward leadership. This helps to allay concerns and sceptics about ESG investing and reinforces the belief that it is possible to achieve risk-adjusted returns by addressing the world’s existential challenges. The commentary was adapted from the conversations of the speakers of the SSP Networking Series event held in the SGX auditorium on 17 October 2022.

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Jau Loong Chow

Prudence or loyalty? Striking a balance between profit and sustainability

Navigating ESG in Asia's challenging investing landscape