Developing a framework: prescriptive rules or principles?17

6 Developing a framework: prescriptive rules or principles?

“The primary risk for trustees in making sustainable investments is around breaching their overarching fiduciary duties to act in the best interests of beneficiaries. ” Trustee Responsibilities and ESG: Identifying Opportunities, Mitigating Risk and Finding Consensus, Jersey Finance

And yet despite all the reasons we have provided about the consistency of ESG and fiduciary duty, concerns are still expressed that the inclusion of consideration of ESG type factors risks undermining fiduciaries’ duty. We explained that this thinking was front of mind for the Trump administration when revising ERISA. But the UN, through its 21st Century Fiduciary Duty initiative, ruled that consideration of ESG factors was a very much necessary exercise. In early sections, we discussed the global implementation of the TCFD reporting requirements. The private wealth sector is, as yet, broadly untouched by these regulatory requirements. But as discussed later, the reporting and regulatory environment in the private wealth sector is unrecognisable from a decade ago and change we believe is inevitable. Guernsey's regulator has led the way in the offshore world with the introduction of consideration of climate risk to its corporate governance code. A discussion of these changes provides some helpful illumination of the issues to hand.

‘5.2.1 Climate Change The Board should consider the impact of climate change on the firm’s business strategy and risk profile and, where appropriate in the judgement of the board, make timely climate change related disclosures' Revisions to the [Guernsey] Corporate Governance Code, 2021 Quite clearly the Code of Corporate Governance relates to regulated firms in the Bailiwick of Guernsey. It prescribes very little other than Board’s should (our italics) consider how climate change may (or may not) affect their business strategy and risk assessment. So, this clearly relates to the Board of the regulated fiduciary and has no impact on the running of any trusts by the firm. Or does it?

What does the regulator mean by the impact of climate change on the firm’s business strategy? Does it mean whether the firm will employ climate change deniers or insist on a walk to work policy? Or should the Board consider the issue more broadly? That is, how and what it will a firm do with regard to climate change and how it relates to, and impacts upon, its clients and their capital entrusted to it?

Once it is accepted that climate change is real and impacts on the future (and current) price of assets, it rapidly becomes clear this issue cannot be swept under the carpet and its consideration is clearly an aspect of fiduciary duty. Afterall, a trustee cannot ignore a risk that might erode capital value. Far from it being a consideration that might be queried as undermining fiduciary duty, it rapidly becomes apparent that its non-consideration is the situation that will undermine the said duty. It becomes clear that the risk in the future is being legally challenged from failing to ensure its consideration. Running through a few questions quickly informs that this is not a tick-box exercise.

Does the firm have concerns with its own reputational risk? What risk appetite does the firm have for stewardships of client investments in fossil fuels? Does the firm need to consider reputation risk for its clients in terms of the investment in nontransition energy sources? The exercise becomes rapidly quite profound when the firm needs to determine how it will treat the risk when considering its fiduciary duty. It is then that it becomes obvious that the assessment of the impact of climate change risk becomes a necessary action. Afterall, it is not hard to imagine the hypothetical future case of failing to draw attention to a high level of exposure of investment portfolios to high carbon emissions intensity assets and a 'candidate for blame' being sought through the courts. In this respect, is it not just sensible working practices to seek to pre-empt such issues. Taking this all into consideration, it becomes quite straightforward to appreciate that the approach taken to clients’ risk becomes a fundamental component of a firm's business strategy. How do we advise our clients treat this risk? How do we quantify such risk? What implications does this have for portfolio mix? What assessment process do we need to ensure takes place? What reporting do we advise is required? What internal processes are required? How do we document our approach? How often is this reviewed? All pertinent questions. None of this detail is prescribed by the Guernsey regulator. But that is the nature of a principles-based approach. It is for firms themselves to determine their own working practices and 'rules' . We take a similar principles-based approach to creating the framework, providing the first few of levels of guidance. Leaving it to practitioners or industry bodies to develop more granularity if desired.