Boost to legal infrastructure behind sustainable investment

Investing for sustainability impact is relevant for all investors and they should consider doing so where it can help meet their financial objectives, said David Rouch, partner at law firm Freshfields, Bruckhaus Deringer and lead author of ‘A Legal Framework for Impact’, the so-called Freshfields Report.

Published last year, it explores to what extent can and should institutional investors use their power and influence to generate a positive sustainability impact, exploring the role of the law in supporting this process.

Speaking at Sustainability in Practice at Cambridge University, Rouch told delegates to continue seeking to influence companies for impact as an effective way to achieve their financial goals.

“Continue doing what you are doing,” he said.

The report, launched by PRI, UNEP FI and The Generation Foundation, lays the foundation for the financial policy reforms needed to reorient investors, markets and economies towards net zero and inclusive, sustainable economic growth.

It follows on from the first Freshfields report of 2005 which concluded that investors are permitted, and arguably required, to integrate ESG factors into their analysis, and the subsequent UNEP FI, PRI and Generation Foundation program: Fiduciary Duty in the 21st Century, which determined that ESG factors must be considered for investors to meet their fiduciary duties. All these legal developments amount to building blocs to the infrastructure supporting sustainability and impact investment.

legal pinch points

The latest report found that across 11 jurisdictions, investors are able to pursue sustainable impacts (via, for example, stewardship, policy engagement or divestment strategies) if they are an effective way of achieving financial goals. Rouch said investors can pursue impact to achieve their financial goals that are put at risk if those impact are ignored. In this way, investors are instrumentally seeking sustainability goals to achieve broader financial goals.

The study has revealed various legal pinch points however. For example, how will pension funds assess if they are having any influence on the third party?

It flagged potential issues around a pension fund’s ability to divest and the importance of investors and asset managers remaining unbiased, continuing to represent all their investor or beneficiary cohort who might care about different impacts.

“Investors have to be impartial,” he said.

Pension funds will also have to factor in cost, balancing the cost of engaging with the impact on the fund. It makes collective action an important decision, he said.

Evidence is a crucial element of the legal process. If investors are ever challenged in court, they may have to provide evidence that the benefit outweighed the cost. He said in such a circumstance, the court will always look at the process behind the decision making; charting how investors take responsible decisions based on evidence and properly consider the risk of sustainability and what the fund can realistically do about it.

“A court will be influenced by good industry practice – but it is virgin territory.”

Collective action

Rouch also noted how successful sustainability and impact investment requires collective action, however this can come with legal challenges.

For instance, one of the challenges with collective action is that the results are enjoyed collectively – and success depends on collective action. It could leave investors struggling to define what contribution they have made to the collective outcome – or what benefit they derived from the collective action.

He said that if by pursuing sustainable impact investors can protect the value of their fund, then logically they should be doing it.

He concluded that one of the biggest challenges is getting people to understand the legal arguments, noting that US investors are particularly anxious around these issues. He said the investment community needed to embed this into their practice outside the legal and consultancy world which is more familiar and comfortable with these concepts.