DealMakers AFRICA 2019 Annual

EC set to extend investors’ duties of care to the public, beneficiaries  and shareholders

by Edline Eva Murungi

Up to now, the boards of institutional investors and asset managers have owed fiduciary duties of care only to their shareholders and companies. In the near future, in the case of investors bound by the European Commission (EC) regulation, this will be broadened significantly, with important implications for investors and the public alike.  

A fiduciary duty is an obligation to act in the best interest of another, and has always been the terrain of corporate law. Traditionally, the Board of a company has a direct responsibility to ensure that the collective interest of shareholders is at the forefront of the decisions made. Where there is a breach of this duty, action against the directors would ordinarily be instituted by the shareholders or people with a direct link to the corporation. 

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Now change is in the air. Under the new EC regulatory framework, intended to facilitate sustainable investment and introduce more transparent disclosure requirements, institutional investors and asset managers will now also owe fiduciary duties of care, skill and prudence to beneficiaries and the general public.


Integrating ESG criteria into investment decisions

The EC’s intention is to ensure investors have sustainable investment processes that take environmental, social and governance (ESG) implications into account. Its new regulation on sustainable investment, published in May 2018, sets out how financial market participants and financial advisors must integrate ESG risks and opportunities into their processes as part of their duty to act in the best interest of investors and beneficiaries. 


This regulation is part of a series of proposals to clarify ESG criteria and ensure uniform disclosure requirements across the investment chain. The move stems from one of the eight recommendations made by the High Level Expert Group (HLEG) on sustainable finance, an advisory body to the EC. 


The next step will be to clarify how asset managers and other investors should take the sustainability factor into account. For this purpose, the EC will start publishing the delegated Acts in December 2019, continuing into 2020 and 2021.


Why should the public be interested in a development of this nature emanating from the EC? The answer is that the development is generally relevant in corporate law everywhere because fiduciary duties are applicable everywhere. In essence, the EC’s approach to sustainable investment makes it clear that ESG and other responsible investment criteria are central, and not tangential, to investment decision-making.

A key change is that investors will be expected to publicly communicate how they integrate ESG factors into their investment decisions. Of particular importance is that they give proper consideration to risk and opportunity exposure, and explain how they are exercising due diligence to avoid, minimise and mitigate negative ESG impacts.


From environmental obligations to anti-corruption issues

In terms of ESG, the new sustainable investment regulation encompasses the implementation of a wide range of obligations, from environmental and social impact considerations to governance and corruption issues.


In ensuring that law works for all, it will be necessary to develop tools to create avenues for collaboration between the private sector and the state, and therefore the general public and beneficiaries.


In terms of legal application, we have seen ESG aspects being considered and integrated into investment agreements, mergers and acquisitions, infrastructure projects and private equity transactions. To date, there has been limited judicial enforcement as a result of the doctrine that silence, absent a duty to disclose, is not misleading.


More active ESG measurement and reporting

What opportunities, in terms of risk and duty, does this new regulation provide? That question will be answered by analysing the roles of the key players.


The EC’s new framework seeks to create a normative, legally binding standard for applying ESG standards and influencing how investment transactions can be structured for sustainable development. If they are to fulfil their broadened fiduciary duties to beneficiaries and the public, corporations will have to be much more active in assessing and accounting for their ESG impacts. This can be done through sustainability committees and by measuring and reporting on how the duty has been upheld. Key compliance on the part of investors will be required by publishing regular reports on the social and environmental impacts of their activities. 


The EC’s strategy is the first plan of this kind to steer a financial sector to help reach climate change goals and, equally importantly, the United Nations Sustainable Development Goals.


However, although the EC regulation is a step in the right direction, in terms of responsible investment, it poses certain challenges.


It is not yet clear what geographical reach the regulation will have, and whether European companies will be required to exercise these duties even in transactions outside the EU. Does the regulation apply to European investors in African countries, for example? What does it mean for parent-subsidiary liability? Most importantly, what reporting requirements will be necessary?


It is also worth noting that the EC released guidelines on non-financial reporting on climate-related information in June 2019. These guidelines offer practical suggestions on what to report, but are non-binding.


Although issues of jurisdiction and applicability of the investors’ duties are yet to be determined, the EC regulation opens up previously uncharted territory by expanding the fiduciary duty of care to beneficiaries and the public. This is likely to usher in a new era of accountability and transparency in institutional investment and asset management. At the same time, care will have to be taken to ensure that the ESG disclosures are introduced without negatively affecting the markets.


Murungi is an Associate with Bowmans, Uganda.