Net zero, lawyers, and fiduciary duty

16 oct 2024

A recent paper from the Net Zero Lawyers Alliance does little to resolve the underlying dilemmas for fiduciaries in relation to climate change

On behalf of the Net Zero Lawyers Alliance, Andrew Wildner and Maurits Dolmans have penned a new polemic: Sustainable Fiduciary Duties – The time has come for financial fiduciaries to adapt to the new climate reality. I make a guest appearance in this article as someone whose errant thinking must be rebutted, so I thought I’d provide my comments on it.  

I actually agree with most of it. Climate change is bad. Mitigating climate change from the trajectory implied by current policies is likely beneficial for portfolio values over the long term. There is therefore a fiduciary case for long-term investors to take a position of preferring more rather than less climate action from where we stand. What fiduciary duties mean in practice evolves with society’s expectations over time, and taking a position on climate helps protect a fiduciary against the later question of “what did you do?”. I also agree that a case can be made even for impact investments which on their own merits might be outside the normal risk return profile of a fund. Engagement, policy engagement, impact investment are all useful tools for investors to deploy.

I’ve written about all this over the last year here and here and came out in a similar place on many of the issues. But the paper does not really address, and certainly doesn’t resolve, the real tensions for fiduciaries in this area.

Fiduciary tensions with climate targets

These tensions and dilemmas, which reside in the detail of the what and how, are as follows.

First, the commonly adopted goal of 1.5C with limited or no overshoot may not be the best outcome for financial portfolio values. The significant upfront costs, disruption, and heavy (and probably suboptimal) government intervention that would be needed to get to this goal from where we are today could quite conceivably outweigh, in financial market terms, the reduced climate damages as compared with a less ambitious climate mitigation goal. Making this comment frequently gets me in hot water in the climate community. And I should emphasise it doesn’t mean we should not strain every sinew as a society to get as close to this goal as possible. But our motivations as a society are not just financial. They incorporate moral concern for the poor and vulnerable, who disproportionately suffer from climate change; obligations to future generations; and non-financial benefits of limiting climate change. Financial markets place little value on any of this so we shouldn’t be surprised if, in the presence of a major unpriced externality, financial market values don’t reflect society’s values. This isn’t a Hollywood movie where the bad guys inevitably lose all their money at the end of the show.

For sure there’s good evidence that bending the curve of global warming from its trajectory of 3C+ (based on current policies) towards meeting the Paris goals reduces portfolio risk and indeed likely increases portfolio values. This forms the basis of a legitimate fiduciary motivation to seek more action on climate. But it’s not so clear that the same can be said for achieving 1.5C with limited or no overshoot. That’s contested. Yes there are tipping points that could occur but they need to be imminent, severe, fast acting and cashflow relevant to make a persuasive financial markets case. So it’s not straightforward for fiduciaries to commit to the 1.5C goal, and before doing so, they should get comfortable they can stand behind it in good faith (I’m not saying they can’t – reasonable people can disagree on this).

Second, investors don’t have a lot of influence over climate outcomes.  People talk about investors “directing capital”. They don’t really do that. They facilitate the flow of capital to profitable opportunities. As with water flowing downhill, investors might be able to redirect the flow a little bit here or there, but gravity will ultimately win out. Profitable opportunities tend to get financed somehow, somewhere. Unprofitable ones don’t, at least not sustainably. People also talk about “forceful stewardship” and “holding companies to account”. But the ability of investors to force companies to do things that are unprofitable or that they simply don’t want to do is pretty limited. I’ve written about this a lot here and here. It’s not that investors have no influence at all, they do, but it’s at the margin. Investors need to calibrate their actions to their influence. Given that investor influence is marginal, it doesn’t sit that comfortably with a very ambitious goal.

Third, the target of 1.5C is now, sadly, very unlikely to be met. So investors adopting this goal face the prospect of using tools that aren’t very powerful to pursue a goal that’s no longer very plausible. They need to consider the fiduciary consequences of this: do their attempts to hit 1.5C leave their beneficiaries worse off in the likely event that the target isn’t achieved. Whether or not they will depends very much on the strategies adopted. Generally, asset allocation strategies – for example portfolio decarbonisation on the assumption of a certain climate outcome or investment in solutions predicated on a certain pace of decarbonisation - do potentially create such risks. Corporate and policy engagement are much less likely to. When adopting a climate goal, fiduciaries need to be careful in adopting it in such a way as to avoid these risks, particularly if the goal is improbable (this was the main point we were trying to make in the article with Iain MacNeil that the authors objected to).

Fourth, while climate change is bad, there is not a cliff-edge at 1.5C that changes everything. Yes, the risks of climate change increase with each fraction of a degree of warming. And yes, poor and vulnerable people around the world, but especially in developing markets, will suffer greatly from our failure to get a grip on this issue. That inherent unfairness is central to the moral bankruptcy of our failure to do better. But developed economies  will survive and adapt for at least some level of warming above 1.5C provided we don’t let climate change get completely out of control. In those scenarios, while not ideal, beneficiaries will still want to have more rather than less money. Sometimes people talk as if we should do whatever it takes to limit warming to 1.5C. Certainly discussion would simplified if the world would come to an end at 1.5C for then there would be no trade-offs. Fortunately, it won’t and so, unfortunately, there are.

Putting all this together, financial fiduciaries have a difficult balance to strike. They need to push for the world as they wish it to be while investing for the world as it is likely to be. This is a delicate balance and in some ways a moving target. It is not amendable to simplistic solutions.

The arguments in response

A few arguments get made to me in response to this.

First is that the 1.5C commitment comes with the rider that it is dependent on government policy, and therefore economic incentives, being aligned with this goal. Therefore any fiduciary problems fall away. Well, if the commitment is truly conditional in that way then it’s not much of a commitment at all, for it merely says: we commit to invest in activities that the government makes profitable from time to time. Any investor could sign up to that. And in any event, certain investment strategies, such as portfolio decarbonisation or asset alignment strategies, which are adopted to meet the goal, are predicated on the 1.5C target, despite government policy clearly not being aligned with it. However, I do accept that this argument is partly true: government policy is not supportive and therefore the investment industry is not doing much. If this makes the case for anything it is not for more ambitious climate targets but for changing the focus of activity - to policy influence.

Second is that the 1.5C target is an aspirational goal that is code for “decarbonise as quickly as possible” and doesn’t really mean 1.5C, as we all know that this is likely out of reach. That’s fine, although that’s not what it says on the tin. And the investment industry can get itself into trouble if it doesn’t do what it says on the tin. Either because it gets accused of greenwashing or because it gets accused of pursuing goals that go well beyond any policy agenda (note that this is a location-specific comment as EU investors can arguably still claim that 1.5C aligns with the EU policy agenda and Danish investors certainly can).

Third is that 1.5C is a political rallying cry that underpins ambition and we cannot have backsliding from it. I have sympathy with this and at the very least, to the extent we are not achieving 1.5C, we should be reminding ourselves of the gap and how far behind the ideal we are. But fiduciaries need to be careful about using other people’s money as a rallying cry especially if that involves them in investment or stewardship activities that otherwise they might not have. They would need to be very clear that’s what their beneficiaries want and that they are prepared to bear any resulting risks.

Fourth is that we don’t know that we’ve missed 1.5C but giving up on it will ensure that we will. This is technically correct, although my understanding is that the possibility of hitting 1.5C is becoming vanishingly low. It is of course perfectly legitimate for each of us as citizens, and for our governments on our behalf, to keep pushing for this goal as long as we can. But fiduciaries face a more sober calculus. Unless expressly authorised by the beneficiaries to do so, they cannot prudently put client money at risk in pursuit of a goal that has a very low probability of success, and over which in any event they have very little influence. There could be ways of carefully crafting the activities in support of the goal that minimise potential harms to clients - for example through focussing exclusively on policy engagement (probably not a bad idea an any event as I will argue elsewhere). But the less plausible the goal the more challenging it will be for fiduciaries to align real investing activity with it.

Fifth is that we are obligated to do whatever it takes to meet the Paris Goals which almost all Governments in the world signed up to. Again I have some sympathy with this, but when we’re using other people’s money to do it we need to think through whether that’s what they really want. The Paris Goals are a broad range from 2C to 1.5C. The emphasis on 1.5C has increased in the last few years is for the very good reason that the science on the risks of climate change has got more troubling even as we’ve had some success in bending the carbon curve. But we can’t take it as automatic that our beneficiaries agree with the greater ambition, as political resistance to even modest decarbonisation efforts testifies. Deciding for ourselves that this is the best way to use client money just invites justifiable backlash and accusations of elite capture. For good or ill we need to address climate change through the democratic process, which is in any case, however flawed, the only game in town to resolve the issue. In the meantime investors need to be carefully about how far they get ahead of the political policy trajectory, but also how they influence it.

Fifth is that driving for 1.5C is what our beneficiaries want and they decide what is in their interests. I’m certainly on board with this as an idea. But the consent from beneficiaries must be clear and informed, in full knowledge of the financial risks that are faced. And I don’t think beneficiary consent can be assumed. The difficulty of getting political support for even fairly modest climate policies once they start costing people money should make us cautious about taking too much as given. But if you can get the informed consent then by all means, go for it. And indeed taking time and effort to find out what your beneficiaries think about this issue is certainly sensible.

Finding common ground

I don’t think it helps to wish these tensions away, because they are real. If we take the approach of the British tourist abroad - saying the same thing again but louder in an attempt to be understood - then a large body of fiduciaries who feel these tensions to be real, will simply disengage from the conversation.

On the other hand, there is a set of propositions that a large group of fiduciaries should be able to agree with, albeit from a starting point of greater or lesser ambition:

• Getting climate change under control is in the financial interests of our beneficiaries (although there may be legitimately different views on what “under control” means)

• Supportive government policy is foundational to making progress on climate change and achieving an economically efficient and just transition

• We want to support governments in achieving this at the most rapid rate consistent with viable political pathways and as a matter of priority will consider how we can make a supportive policy pathway more likely

• We will use our marginal influence with companies to seek more rather than less decarbonisation wherever possible but recognising this needs to be consistent with long-term value creation

• The world is decarbonising, quite likely faster than we think, so we will take this into account in our investment strategy and stewardship so as to manage the risks and capture the opportunities from this decarbonisation trend

• However, we can only affect the climate outcome to a very marginal extent so to protect the interests of our beneficiaries we have to balance pushing for the world as it we would like it to be while investing for the world as it is likely to be - exactly what this balance entails is likely to evolve over time

In practice, many investors who have signed up to 1.5C targets are doing less even than this. Too many are simply adopting portfolio decarbonisation targets, engaging with companies on disclosure commitments, and undertaking “climate solutions” investments that would likely make sense anyway. This is activity that appears to be 1.5C aligned but isn’t really achieving anything. Of course there are investors who in good faith are doing their best with greater ambition and with some limited but positive results. But for the larger mass of investors, perhaps it would be better to doggedly pursue more realistic goals that at least had modest impact.

I don’t see this as encouraging everyone to race towards a cliff, which the authors suggested was the implication of my views. Instead, I view it as asking fiduciaries to do what they should always be doing: thoughtfully balancing a range of difficult issues in the long-term interests of their beneficiaries. That is, fulfilling their fiduciary duty.

I think that climate change could be bad, really bad, for society, the economy, and, especially, for poor and vulnerable people around the world. We should be doing more than we are to bring it under control. But we need to be clear-eyed about the incentives and obligations different actors in our system face, be open about the range of views that can reasonably be held on uncertain matters, and always remember where the solutions and agency really lie. The facts always catch up with us in the end, so it’s best to acknowledge them in the first place.

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