Finance

Box 5: Financial materiality and fiduciary responsibility (KfW Symposium 2008)

In 2003, a group of asset managers (UNEP FI AMWG 2004-2009) collectively representing US$ 1.7 trillion in AUM began to reconsider the financial materiality of a range of ESG issues that until then had traditionally been overlooked or undervalued by many investment approaches. Over subsequent years, the process yielded three major reports that have transformed thinking within the investment world.

In the Materiality Series (UNEP FI Materiality Series 2004 to 2010) mainstream financial analysts explored the relevance of a range of ESG issues, such as climate change, occupational and public health, human labour and political

rights, and both corporate trust and

governance, across a range of commercial and industrial sectors.

The sectors included aviation, the auto

industry, aerospace and defence, chemicals, food and beverage,

forest products, media, non-life insurance,

pharmaceuticals, property, and utilities. What the Materiality Series was so effective in doing was to hold the coming-out ball for the idea that ESG (particularly environmental and social) factors have financial relevance, and are as useful in constructing a synthesis of management quality as strictly financial factors.

The Materiality Series also helped lay the groundwork for the development of the PRI, now backed by more than 900 institutional investors representing US$ 25 trillion in assets4

. The third and, to date, final report

in the series focused on climate change and was published just two months ahead of the December 2009 United Nations Climate Change Conference in Copenhagen. The report mainly takes the form of a review of key financial analyst research on climate change.

Along with the growing acceptance of the financial materiality of ESG issues, parallel work was undertaken to show that considering ESG issues in investment policy making and decision making was consistent with legal frameworks that govern the fiduciary duty of many institutional investors to act

4.2 Providing pre-investment finance

At least 83 countries now have some type of policy designed to promote sustainable energy, but only a few have seen scaled-up investment in renewable energy

4. The Principles for Responsible Investment (PRI), launched in April 2006, is an investor initiative backed by United Nations Environment Programme Finance Initiative and the UN Global Compact. www.unpri.org

in the best interests of their beneficiaries. In October

2005, a landmark legal interpretation covering the nine major capital market jurisdictions opened up a new potential for the world’s largest institutional investors to consider ESG issues in their investment processes (UNEP FI and Freshfields Bruckhaus Deringer 2005). In fact, the interpretation argued that the appropriate consideration of ESG issues – from both risk and reward standpoints – was an obligation in most major capital market jurisdictions and mandated by law in some. The Freshfields Report greatly strengthened the case within the investment industry around the need for investors to fully integrate material ESG considerations in all aspects of their investment processes. In short, this work moved the discussion forward on the need for key market actors to integrate, account for and price the risks associated with a broader range of externalities than had previously been the case in investment practice. The Freshfields legal interpretation was followed in 2009 by the Fiduciary II (UNEP FI 2009) report that built on the initial interpretation. The Fiduciary II report concludes that ESG issues should be embedded in the legal contract between asset owners and asset managers, with the implementation of this framework being governed via ESG-inclusive reporting to asset owners. It also makes a case that advisors to institutional investors, such as asset managers and investment consultants, have a duty to proactively raise ESG issues with their clients, and that those who do not open themselves to potential legal liabilities. Finally, the study argues that responsible investment should be the default position for all investment arrangements. To achieve this the fiduciary duty should be aligned better with environmental and social dimensions. This evolving process that seen ESG issues being embedded in the thinking around fiduciary responsibility and legal considerations goes to the very heart of many investment policy making and decision making processes.

and energy efficiency operations (REN21 2010). Analysis suggests that one of the most important barriers to scaling up is the lack of pre-investment finance. Figure 4 demonstrates the phases of investment, from public grants, VC funding, and production subsidies required to develop a new renewable energy technology to the point that it can begin to demonstrate a track record and attract second stage funding. Figure 5 shows the private

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