Wednesday, July 15, 2009

Institutional advisors at risk, UN report warns

Advisors to institutional investors have a duty to proactively raise environmental, social and governance (ESG) issues with their clients, according to a new UN-backed report.

“Fiduciary responsibility,” released by the asset management working group of the United Nations Environment Programme’s Finance Initiative, warns that investment consultants or asset managers who fail to do so run the risk of being sued for negligence.

“We believe that embedding ESG issues in their legal contracts will help asset owners hold asset managers to account for delivering on this important aspect of asset management,” the report states. “Similarly, all consultants, asset managers and other service providers that are signatories to the UN’s Principles for Responsible Investment should make a commitment to proactively raise ESG issues within their advisory and client take-on process.”

The report consulted fiduciary law expert Paul Watchman, chief executive of Quayle Watchman Consulting. “As professional investment advisers, investment consultants and asset managers are under a contract for services rather than a contract of service. They are professional advisers to the client, not employees of the client; hence in exercising significant professional discretion, investment consultants and asset managers must be proactive rather than reactive,” Watchman said.

Furthermore, Watchman brings ESG integration to the point of contract by advising that “it is necessary for investment management agreements or the equivalent contract between pension funds and asset managers to use ESG language in order to clarify the expectations of the parties to the contract. In particular, it is important that it is made absolutely clear to beneficiaries, pension fund trustees and asset managers that ESG is regarded as a mainstream investment consideration.”

The report states that responsible investment, active ownership and the promotion of sustainable business practices should be a routine part of all investment arrangements, rather than the optional add on which many consultants appear to treat it as.

This report is a sequel to the 2005 Freshfields report, which promoted the integration of ESG issues into institutional investment.

Overall, the key conclusions of this latest report is that in order to achieve the vision of the original Freshfields report, where trustees integrate ESG issues into their decision-making, ESG issues should be embedded in the legal contract between asset owners and asset managers, with the implementation of this framework being governed by trustees via client reporting. The new report also makes a case for consultants having a duty to proactively raise ESG issues with the advisory process.

Link to download report.

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