By Dr Mark Hinnells, director of Susenco Consulting Ltd, London and Hong Kong

Fiduciary duty is the obligation of a decision-maker to act in the best interests of their client. Trustees, fund managers, directors – even cabinet ministers – have a fiduciary duty. The whole financial system rests on discharging it appropriately. Should the discharge of fiduciary duty have regard to environment, social and governance (ESG) issues and climate change? And if so, how? 

Which is more important: ESG or climate  

Environment, social issues and governance issues are not created equally. The E should be for ‘existential’ risk: both climate and biodiversity risks. In the case of the S and G, it is harder to measure impacts, opportunities and costs objectively; and different practices in different countries mean standards are not universal. 

Climate change impacts and risks can not only be measured, but there is a legal chain of obligation – from the Paris Agreement 2015 to agree for the world to halve emissions by 2030 and achieve net-zero emissions by mid-century; through to the Nationally Determined Contributions, or commitments each member state of the UN makes; through to national policy, which varies widely but is moving towards incentivising carbon emissions reduction in investments and assets. 

At corporate level, some forty stock exchanges have implemented a common reporting framework for both ESG and for climate (under IFRS S1 and S2) and there is an emerging framework for pricing carbon – the World Bank estimates that around a quarter of the world’s carbon emissions are in a carbon market. 

That makes it much easier to incorporate climate into financial reporting and risk management. Biodiversity is following. As Mark Carney put it when he was Governor of the Bank of England: “Unless we put a price on carbon, we end up with a misallocation of capital.” 

Climate change and the financial system 

There is an intimate and inevitable linkage between climate, risk and the future of capitalism: 

• CO2 emissions directly increase the amount of energy trapped in the Earth’s atmosphere.
• Extreme weather drives direct physical risks to all categories of assets.
• The insurance industry has historically managed those risks, but premiums in some places are starting to exceed what people or companies can pay, or insurers won’t carry the risk.
• That is a systemic risk: an asset that cannot be insured cannot be financed. That could become a climate-induced credit crunch.
• Some argue that the state would step in where insurers withdraw. But that assumes the state – ie the taxpayer – wants to, or can afford to.
• Many risks do not lend themselves to meaningful adaptation; for example, cities built at sea level are hard to relocate.
• At a certain level of warming, risk cannot be transferred (no insurance); risk cannot be absorbed (no public capacity); and risk cannot be adapted to (physical limits exceeded).
• Mortgages, insurance and investment products like pensions and life insurance would all be affected, with much greater financial instability. That is an existential threat to capitalism and an invitation for litigation.

The societal costs of climate change have been studied extensively and estimates vary from 20% of global GDP by 2050 to 50% by 2080 or so – this latter by the Institute and Faculty of Actuaries. Those risks mean their consideration in long-term wealth management is a fundamental part of the duty of a fiduciary. How is that being translated into policy? 

In the UK climate change is now a clear part of fiduciary duty. The Pensions Regulator requires a ‘Statement of Investment Principles’, which must consider ‘financially material considerations over the appropriate time horizon of investments [long enough to consider environment, including climate change]’. The Pensions Schemes Act 2021 (S124) puts Paris Agreement targets on the face of pensions legislation, and reinforces fiduciaries’ duties to act in the best interests of scheme members regarding climate change. 

Other jurisdictions are following with a patchwork of law, policy and guidance, redefining Fiduciary Duty. 

Court cases 

For the time being the courts appear to be deferential to whatever approach fiduciaries choose to adopt to ESG and climate change. For example: 

• In McGaughey v Universities Superannuation Scheme: A challenge on grounds of insufficient action on climate risk was rejected, though the court did not engage with the risk of future loss.
• In ClientEarth v Shell: The English High Court rejected a claim against Shell's directors for failing to address climate change. The court concluded that decisions on a company’s strategy are a matter for directors, not the court or claimants.
• In Butler-Sloss v Charity Commission: Paris Agreement-aligned investments by charitable trustees were seen as appropriate by the court, even when they didn't maximise financial returns, because Paris Agreement alignment was consistent with the purpose of the trust.
• In Wong v New York City Employees Retirement System: Plaintiffs claimed pension trusts did not maximise returns and instead impermissibly pursued a pro-ESG policy agenda. The case was summarily dismissed.

How long courts will allow fiduciaries freedom to ignore Paris Agreement targets and national policy remains to be seen. 

Conclusion 

In conclusion, ESG and climate carry both risk and opportunity. Fiduciaries may have a duty to report and a duty to manage risk, with implications for changed investment priorities and plans. Increasingly, investors and beneficiaries are taking an interest in decisions made by fiduciaries. Disagreements may need advice, arbitration or even a court decision. Susenco would be happy to help in those circumstances. 

Dr Mark Hinnells Energy and Climate Change Expert 
T: 01865 600161 
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