2. socially responsible investing

Before we can examine the rationales for SRI, it is necessary to understand a bit about its history, methods and objectives. The SRI movement has surged to prominence since the early 2000s in a world troubled by economic and environmental concerns. The GFC unveiled profound weaknesses in the conventional paradigm of market finance, highlighting a need to rethink its fundamental tenets and purpose. Concomitantly, the rapid degradation of the biosphere imperils human well-being, with climate change looming as the most ominous risk. While finance capitalism has been excoriated for being a vector of economic crisis,^{Footnote 8} its contribution to environmental unsustainability is less well acknowledged.^{Footnote 9} Both problems stem from some similar underlying flaws in the market economy – in particular, its failure to take into account very long-term preconditions to human welfare and prosperity.

SRI raises the spectre of more enlightened investing that is not predicated solely on maximizing financial returns.^{Footnote 10} It can be interpreted as a reaction to the impacts of a flawed economic system and the failure of states to regulate it. As the economy fails to fulfil people’s desires and governments fail to intercede, dissatisfied consumers and investors may reach for alternatives. The fair trade movement, green consumerism and social investment are all variations of this stance. Activists without financial resources may prefer overt protest, as exemplified by the recent Occupy Movement.^{Footnote 11}

With a history of challenging unethical activities, SRI draws upon a variety of methods, of which the mainstay have been screening investments in certain industries or companies because of the characteristics of their products or operations, or engaging with businesses to encourage them to improve their behaviour. These methods are known respectively as portfolio screening (typically either by excluding ‘bad’ companies or including ‘good’ companies in an investment portfolio) and corporate engagement and activism (such as through the exercise of shareholder rights). As will be discussed shortly, these methods also coincide somewhat with specific rationales of SRI, with divestment closely associated with the complicity doctrine and engagement more associated with leverage-based responsibility.

SRI has a record of serial attachment to disparate causes dating from the 18^th century when the Quakers proscribed financial ties with the slave trade. Later, many Christian faiths screened their portfolios to avoid alcohol, tobacco, gambling and other ‘sin stocks’.^{Footnote 12} In the 1970s, a global divestment campaign against firms profiting from South Africa’s apartheid regime began. Today, SRI covers a larger miscellany of causes and issues, including climate change, food safety, child labour and much more. If it can attract enough adherents, SRI may resemble a style of market governance, supplementing official regulation by disciplining corporate irresponsibility when states do not. Since many companies rely on debt or equity funding to sustain their activities, investors may, in theory, influence corporations by making finance conditional on environmental and social performance.^{Footnote 13} In a transnational setting, SRI could be a valuable tool of market control by helping to close the governance gaps in international law that has left financial markets only lightly regulated, and has addressed their environmental sequelae hardly at all.

Much of the SRI sector’s impact has gone beyond discrete divestment campaigns or engagement with specific companies, to more comprehensive strategies that include drafting governance codes of conduct and undertaking dialogue with entire economic sectors. Examples of the former include the United Nations Principles for Responsible Investing (UNPRI)^{Footnote 14} and the Equator Principles,^{Footnote 15} the impact of which I have examined elsewhere in my scholarship.^{Footnote 16} An example of the latter strategy is the Institutional Investors Group on Climate Change, which aims to promote a better understanding of the implications of climate change among investors, to encourage companies and markets in which its members invest to address any material risks and opportunities of global warming, and to promote broader dialogue and collaboration with stakeholders transnationally. These initiatives display most strikingly the aspirations of some social investors to govern the market.

The foregoing efforts of social investors to enunciate new standards and codes may also be viewed as an emerging form of ‘global administrative law’, to use a phrase coined by some legal theorists.^{Footnote 17} The SRI industry’s production and dissemination of procedures and principles relating to consultation, transparency and accountability for financial markets, as well as its consideration of sustainability issues, resonate a kind of global, private administrative governance. This emerging governance space that transcends formal intergovernmental legal regimes may become important in defining acceptable standards for fiduciary finance in a global context. As noted in the concluding section of this article, one of the challenges to operationalizing a new rationale of SRI directed to long-term investing for sustainability will be to give the global debates about what should constitute ‘prudent’ investment greater traction through legal institutions.

But as mainstream institutional investors in global markets have begun to embrace SRI, they have somewhat distanced themselves from the more overtly ethical or policing stance championed by some social investors. This is primarily because such conduct is perceived to be financially imprudent and incongruous with their fiduciary responsibility. They have purged SRI’s more radical ethical agenda to reframe it as a technical paradigm of financial risk management. This ‘business case’ mode of SRI is increasingly known as ‘ESG analysis’, referring to the potential salience of ‘environmental, social and governance’ (ESG) issues to financial risk or reward.^{Footnote 18} The SRI ‘industry’ – now a more accurate expression than ‘movement’ – has become preoccupied with financial returns rather than the evaluation of its social and environmental impact and ability to improve corporate behaviour.

Ostensibly, SRI has acquired some respectability in Western Europe and North America, its main markets, with some industry-sponsored research boasting that between 10 to 20% of investment portfolios are now managed for SRI purposes.^{Footnote 19} However, these surveys exaggerate the market size as a result of some rather broad and indiscriminating definitions of SRI that include much financial activity that is little different from conventional investment. This discrepancy hints at a more fundamental cleavage within the SRI sector between those who believe that it involves merely ‘taking into account’ ESG issues that affect financial performance^{Footnote 20} and those who demand prioritization of ethical considerations.^{Footnote 21} As will be discussed shortly, the UO thesis has emerged in an attempt to overcome the antagonism between these ethical and financial imperatives.

The following sections examine the major theoretical rationales behind SRI, beginning with the oldest rationale, the complicity-based doctrine. The discussion illustrates the changing pretext for SRI and the increasing attempt to refashion SRI into an investment practice compatible with the financial goals and legal responsibilities of institutional investors.

3. the complicity-based doctrine

‘Complicity’ is sometimes cited as the touchstone for attributing responsibility to investors or companies for social harm, and it informs the SRI policy of the Norwegian Government Pension Fund-Global (NGPF-G), the world’s largest sovereign wealth fund.^{Footnote 22} The notion of complicity has considerable legal and ethical heritage, and its legal connotations have been enumerated most clearly in the area of aiding international crimes and violating human rights.^{Footnote 23} Complicity essentially means indirect involvement by actors in abusive conduct where another party commits the actual harm. It has been a formative ethical doctrine for some SRI practitioners because investing in companies can lead to one being regarded as an accessory or accomplice to their misdeeds. The complicity doctrine can also be understood in terms of the methods of SRI, it being associated most commonly with divestment from problematic entities with which one wishes to eschew association.

When Norway sought to develop SRI regulations for the NGPF-G, it appointed a committee of experts to advise on the appropriate normative framework. The committee rationalized ‘ethical investment’ (its preferred phrase) primarily on the ground that the NGPF-G should avoid complicity in gross or systematic breaches of ethical norms relating to human rights and the environment:

The committee elaborated that the substantive moral criteria to judge such ‘gross unethical actions’ should be informed by international agreements on environmental protection and human rights that Norway supports. It reasoned that while most international obligations apply only to states, companies may aggravate or facilitate violations committed by states, and the NGPF-G might subsequently contribute to the misconduct of companies through its stock ownership. While excluding companies from the NGPF-G might influence their behaviour, the committee focused on refusing investment as a means of avoiding the Fund’s own complicity in ethically problematic activities in addition to any influence achieved by engagement and dialogue with corporate managers.

Legally binding regulations (misleadingly labelled as ‘Guidelines’) inspired by the above considerations were adopted for the NGPF-G in late 2004 and revised in 2010, with a Council on Ethics concurrently appointed to evaluate potential investments for compliance.^{Footnote 25} The Guidelines specify exclusion of companies related to enumerated products such as tobacco and certain military weapons. The Guidelines also direct exclusion in a secondary category relating to corporate conduct that the Ministry of Finance, on the advice of the Council, believes is ‘an unacceptable risk that the company contributes to or is responsible for’.^{Footnote 26} Such conduct includes:

Within these categories, which already pitch a high threshold for offending conduct, the ‘aim is to target [the] worst case[s]’.^{Footnote 28} Consequently, some unethical behaviour will be overlooked.

The Norwegian fund’s approach is a form of deontological ethics, as also found in older traditions of ethical investing associated with faith-based investors.^{Footnote 29} Deontological ethics judges the morality of our actions in specific features of the acts themselves, regardless of their consequences. One strand of this ethics is the divine command doctrine, associated with morally absolutist stances taken by religious groups. Another deontological approach is Immanuel Kant’s theory that morality rests on inherent moral duties discoverable by rational people.^{Footnote 30} Kant believed that through reasoning, rational individuals would reach the same conclusions, providing an objective and universal morality. Natural law theory is yet another variant of the deontological tradition, emphasizing the inculcation of law with fundamental moral norms.^{Footnote 31} These ethical approaches can influence SRI that calls for respect for universal, ‘fundamental’ human rights or avoidance of support for ‘sinful’ activities such as gaming or alcohol-related businesses.^{Footnote 32} This style of SRI is not overtly intended to change the behaviour of shunned companies as an explicit goal, although arguably, like other SRI behaviour, it is implicitly trying to sway the companies in question if only by depriving them of needed capital.

Although the NGPF-G and faith-based investors are renowned for some of the most principled approaches to SRI, the complicity doctrine is not an adequate normative rationale for SRI and cannot comprehensively define the parameters of investor responsibility for sustainability. Firstly, complicity has a negative orientation, focusing on avoiding association with actors that perpetrate harms rather than encouraging investment portfolios that prioritize sustainability. Avoiding companies that waste the environment leaves untouched the need to promote positive practices. A second deficiency is that complicity places the threshold for divestment or other investor sanctions too high, requiring gross violation of human rights or severe environmental damage, for example; but much injustice or ecological degradation arises incrementally from actions or omissions that, viewed in isolation, might seem trivial. As Judith Lichtenberg explains, harm is ‘essentially aggregative: there is nothing intrinsically harmful to the environment or other people in burning fossil fuels; the harms depend on the joint effects of many people’s action’.^{Footnote 33} Thirdly, complicity may be a problematic ethical standard for a culturally and morally diverse world in which investors have divergent views about ‘what is right’. For example, the moral absolutism of divine command provides no guidance when moral imperatives clash: some social investors categorically oppose investing in nuclear power while some might believe this form of energy is a climate-friendly alternative to fossil fuels. Moral judgments in Kantian theory are also problematic to defend. As the theory focuses on the reasons behind actions rather than on the actions themselves, it can be hard to universalize moral axioms without knowing the motivating reason underlying someone else’s action.

A further concern with the complicity doctrine is its conceptual confusion and imprecision regarding the degree of knowledge or assistance necessary to trigger consequences. Notions of ‘impact’ and ‘influence’ are not easily measurable. ‘Complicity’, as a legal concept, can attribute liability to actors in various situations ranging from direct complicity (where one knowingly assists another in committing a legal violation) to beneficial complicity (where one benefits directly from the violation committed by someone else).^{Footnote 34} Thus, at one pole, an actor might be condemned as being complicit for providing practical assistance or encouraging others to commit the harm; at another extreme, merely deriving a benefit from another’s human rights abuse or environmental crime might suffice. Clearly demarcating the requisite degree of proximity between investors and the resulting harm to trigger moral or legal responsibility is fraught with challenges. Christopher Kutz suggests that ‘[g]iven the complex intertwining of capital in a globalized world, it is inevitable that any investment decision would link one to wrongdoing in some form’.^{Footnote 35} From a legal perspective, such a ‘link’ can sometimes be established only tenuously, because the chain of causation between the investment and the resulting harm may be weak. Thus, some scholars of criminal law and human rights law invite abandoning the complicity doctrine.^{Footnote 36}

Although complicity is not a comprehensive rationale for SRI and can only capture a few particularly salient environmental issues, it has garnered some influence in financial markets through the related concept of ‘reputational risks’ to those associated with problematic businesses. For example, the Australian ANZ bank refused a loan worth AUD$2 billion to Gunns, a forestry company wishing to build a pulp mill in Tasmania, apparently based on reputational concern associated with the project’s grave environmental impact.^{Footnote 37} The SRI industry is also pioneering more nuanced methods to quantify the economic value of environmental and social performance to a company’s brand name in order to help investors factor such performance into their decision-making. Reputational value can be significant. Robert Eccles summarizes that:

Yet reputational risk to companies or their financiers is not a proxy for all underlying societal concerns, and most investors will respond only to the usually more limited ‘financial materiality’ of the reputational risk, rather than its unadulterated ethical significance.

4. leverage-based responsibility

A second commonly advanced rationale for SRI is that it provides a means for investors to improve the social and environmental performance of companies and the economy at large. This rationale hinges on the belief that social investors should use their available leverage to influence the behaviour of targeted companies. As Stepan Wood explains, ‘[t]he kernel of a leverage-based approach is the proposition that, in some circumstances [an entity] has a responsibility to exercise its leverage over actors with whom it has relationships in an effort to improve that state of affairs’.^{Footnote 39} Thus, rather than basing the morality of investing on any intrinsic goodness or wrongness by deference to human reasoning or divine will, this teleological approach to SRI judges morality by the consequences of investors’ actions. Where an investor can influence a company to do good or to avoid harm, these positive consequences behove it to invest ethically. This approach has influenced SRI most notably in the South African divestment campaign of the 1970s and 1980s that aimed to topple the apartheid regime.^{Footnote 40} Some commentators believe that the teleological approach can offer a robust framework for SRI by enabling ‘a clear, simple and direct link … between harmful corporate behaviour and the moral reasons for opposing it’.^{Footnote 41} This rationale of SRI is increasingly associated with corporate engagement, a method by which social investors use their leverage as shareholders or financiers to foster dialogue with companies in the hope of changing their practices and policies.

An important challenge for this SRI rationale is setting credible thresholds and parameters for when investors should seek to exert influence. Most obviously, ethical responsibility can arise where investors have an impact on corporate environmental behaviour established by a causal connection, as when a bank provides a substantial loan for a major development project. Here, the nexus between the actions of the financier and the funded project is clear, and responsibility for taking remedial action (including withholding finance or imposing environmental conditions on the loan, as well as lender liability for any residual ecological damage) should be proportionate to the financier’s degree of contribution.

A wider penumbra of responsibility is suggested by some commentators when an economic entity sits within a ‘sphere of influence’. This idea is developed cleverly by Stepan Wood^{Footnote 42} and Lene Bomann-Larsen and Oddny Wiggen,^{Footnote 43} who emphasize the diffuse web of relationships that a business or other economic actor may have with associated companies, customers, local communities and other parties. Thus, a financier or investor might share responsibility not because of any specific contributory behaviour, but because of its omissions and failure to exercise leverage over others when it should have and could have made a difference. This wider view of leverage-based responsibility appears in the preamble of the UN Global Compact of 2000,^{Footnote 44} and the draft UN Norms on the Responsibilities of Transnational Corporations, proposed in 2003.^{Footnote 45} However, the sphere of influence yardstick was later rejected by John Ruggie, Special Representative of the UN Secretary-General for business and human rights, who argued that it represents ‘a useful metaphor for companies in thinking about their human rights impacts’ outside their own organizational boundaries, but ‘a more rigorous approach is required to define the specific parameters of [their] responsibility to respect human rights’,^{Footnote 46} and it might lead to companies’ performing roles that should be played by states. By contrast, the sphere of influence yardstick is acknowledged in the International Organization for Standardization’s (ISO) recent 26000 guidance on corporate social responsibility.^{Footnote 47}

By this approach, therefore, this rationale for SRI stems from the potential of some financial actors to wield positive influence and leverage to promote social and environmental ‘returns’ to society. The expectation arises most directly when a financier has a material connection with a business (for example, ownership of its securities) where the business itself can make a difference to its environmental and social behaviour through operational changes, and the cost to the financial institution of acting responsibly, such as through corporate engagement, is reasonably affordable. Leverage-based responsibility to invest sustainably is thus not an absolute and open-ended standard, but rather is qualified depending on the specific context and circumstances.

As with the complicity rationale for SRI, leverage-based responsibility can only push SRI so far. The theory is attractive and persuasive with regard to regular business corporations, but less applicable to financial institutions and markets. Firstly, it does not provide a compelling rationale for investors to take action when they lack leverage or influence. Even if a financier is unable to sway a particular company, it may still be in its long-term financial self-interest to take account of environmental impacts such as climate change. (This issue is explored further in later sections of this article.) Secondly, in many financial transactions it would be impossible to satisfy the criterion of a ‘material connection’ or lesser threshold of a ‘web of influence’; the array of relationships between corporations and the financial sector is immense and diverse. The financial ties are tenuous and fleeting, such as in a large pension fund in which ‘the average traded firm … [is] just one stock in large diversified portfolios’.^{Footnote 48} Investors participate in financial markets through many layers and chains of intermediaries, and even the very largest actors, such as sovereign wealth funds like the NGPF-G, typically own only a wee fraction of the total shares issued by an individual company. Relatedly, much incremental and occasional environmental harm cannot be captured by a leverage-based standard of responsibility, because individual contributions to consequences are not easily ascertained or quantified. Such circumstances require more nuanced judgments of culpability. Thus, while the collective influence of investors may be significant, that of an individual fund in relation to any specific company is typically greatly diluted and difficult to discern. As with complicity, rationalizing SRI on its basis to leverage positive consequences can fail to capture many dimensions relevant to the sustainability of the financial economy at large.

Furthermore, as a matter of current practice to overcome, most financial institutions would baulk at the suggestion that they have a responsibility to exercise leverage. Even among social investors, most disavow any pretence of being surrogate regulators, as they do not view themselves as qualified, capable or authorized to police the market.^{Footnote 49} Only a minority of deeply ethical investors, such as those associated with religious and activist groups, would regard their mission as including civilization of the market. The rest of the financial industry largely views itself as simply tied passively to its clients and borrowers, and not meant to meddle in their policies and operational practices unless those policies and practices overtly jeopardize the industry’s financial interests. Thus, social investors face formidable challenges in impressing upon the financial sector a responsibility to govern the market for sustainability more broadly.

5. the universal owner thesis

The UO thesis, proposed by Robert Monks and Nell Minnow^{Footnote 50} and elaborated by James Hawley and Andrew Williams,^{Footnote 51} is both a descriptive proposition about how some institutional investors already behave and a normative theory about how they all should. It implies that large institutional investors are sufficiently diversified in the economy that they should be motivated to curb environmental pollution and other harmful externalities. Global banks holding substantial and diverse lending portfolios may also be considered to have such ‘universal’ characteristics. Hawley and Williams explain:

Because the UO approach posits that the portfolios of the biggest financial institutions are of such a size that they effectively ‘own the economy’, their fiduciary mandate to safeguard their assets is effectively a mandate to safeguard the economy by being attentive to social and environmental costs and benefits. These investors should be self-interested in the health and sustainability of the entire economy because they ‘have no interest in abetting behaviour by any one company that yields a short-term boost while threatening harm to the economic system as a whole’.^{Footnote 53} As their investment portfolios are closely tied to the overall health of the economy, universal investors should be concerned about any ecological impacts that might erode financial returns. The related notion of the ‘civic investor’ is advanced by Franck Amalric in his characterization of the structural interest of pension funds in caring about environmental externalities.^{Footnote 54}

Expressed differently, the UO or civic investor thesis suggests a way to resolve, in the context of financial markets, the generic collective action paradox mapped by Garrett Hardin^{Footnote 55} and Mancur Olson,^{Footnote 56} where seemingly rational choices for individuals are irrational for society collectively. In contrast to lone investors with incentives to exploit market failures for personal gain, which ultimately leaves all worse off as the externalities accumulate, UOs should be motivated to act in the interests of all.

A few institutional investors acknowledge the UO thesis explicitly as a rationale for their SRI practices. The British Universities Superannuation Scheme (USS) declares ‘its role as a Universal Investor. Here, the Fund has an interest in minimising externalities and market failures (e.g. pollution or weak corporate governance controls) that would affect economic performance’.^{Footnote 57} Also, the policy of the French Pension Reserve Funds (Fonds de Réserve pour les Retraites) explains that the ‘performance of investments does not depend only on the impact of the financial and extra-financial strategy of the companies, but also on the impacts that they generate for the industry in which they operate or for the whole economy’.^{Footnote 58} Thus, the French fund believes ‘[a]n analysis of these externalities, positive or negative, and therefore of the environmental and social sustainability of corporate strategies and their implications for the community, is necessary’.^{Footnote 59}

In practice, some institutional funds appear to be implementing this ‘universal’ approach, investing positively in social and environmental initiatives while seeking to bolster their portfolio returns.^{Footnote 60} The California Public Employees Retirement System (CalPERS) has recently invested US$800 million in infrastructure projects, and the Teachers Insurance and Annuity Association–College Retirement Equities Fund (TIAA-CREF) has contributed US$50 million to Good Energies Inc. for energy efficiency projects. The NGPF-G has also initiated a positive investment programme to deliver environmental or social returns in addition to financial returns, and has published an ‘expectations’ document regarding companies’ management of risk factors relating to climate change.^{Footnote 61} However, such examples do not represent how most financial institutions invest, and the extraordinary growth of financial markets in recent decades has coincided with a significant decline in the health of the global biosphere.^{Footnote 62}

The UO thesis has some conceptual weaknesses that suggest that such a shift in investor practice is no assurance that the environmental footprint of the financial sector would materially improve. First, the thesis cannot explain how environmental externalities in aggregate may become internalized in the economy. Many externalities, such as the disappearance of species or toxic substances in the food chain, can occur without manifesting any discernible economic cost, at least not in the short term. Some noble attempts have been made to quantify such economic costs: a study by two UN bodies in 2008 calculated the cost of the major types of ecological externality caused by the world’s largest 3,000 companies at US$2.15 trillion.^{Footnote 63} Another report prepared for the UN evaluated the price of environmental damage worldwide to which the companies in a representative investment portfolio contribute, and estimated this in 2008 to be US$6.6 trillion (or 11% of global gross domestic product (GDP)).^{Footnote 64} The report expects such costs to grow to US$28.6 trillion (18% of projected global GDP) by 2050.^{Footnote 65} However, it is misleading to extrapolate that ‘a large proportion of these externalities were internalized by firms owned by universal investors, actively reducing the value of other firms in the portfolio’.^{Footnote 66}

While an economy-wide investor might be willing to scrutinize the externalities of individual companies, the economy as a whole does not necessarily internalize all those costs. Markets lack an internal mechanism to constrain the economy’s total resource use or pollution load within biosphere limits.^{Footnote 67} While many investors are surely aware that climate change is both a serious environmental and economic problem, they struggle to coordinate their activities to limit investment in fossil fuel industries or other sources of global environmental pressure in a competitive market. (Such coordination typically requires governmental intervention, such as through a carbon cap-and-trade scheme.) Also, some environmental values are too remote temporally or spatially for markets to recognize.^{Footnote 68} In any event, any UO would presumably not be interested in externalities proportional to their impact on social welfare, but rather only in those corresponding with their adverse effect on the prosperity of the economic assets the fund holds. Thus, we cannot assume that investors view the current health of the economy as a whole as a proxy for the long-term health of the biosphere.

Further criticisms of the UO thesis or its assumptions can be made. One is that financiers commonly focus on the credit risks of individual borrowers or the financial risks of a specific security. While investors design diversified portfolios to minimize overall financial risks, they tend to evaluate assets on a case-by-case basis (especially in the case of project financing loans). Thus, constraints arise when institutions have characteristics of UOs but rely on one-off or narrowly framed analytical techniques in evaluating financial transactions. Another criticism derives from the management of investment portfolios. The portfolio of large institutional investors is commonly dispersed over several asset management companies, possibly resulting in each portfolio being narrower than the original ‘universal’ portfolio (for example, because they focus on a specific geographic region or industry sector). Moreover, as portfolio management is commonly delegated to specialist fund managers hired on limited-term performance contracts, pressures for short-term or opportunistic investing intensify.^{Footnote 69} Finally, the argument that UOs invest responsibly because they are accountable to a broad investor base is questionable. While institutional intermediaries have given mass society a stake in the financial markets, these funds do not represent all stakeholders in society, especially the poor or unemployed, and they do not represent future generations.^{Footnote 70} In sum, it is not persuasive to proclaim that simply because an investor with an economy-wide portfolio is potentially exposed to an array of externalities, that investor will or should thereby ‘internalize’ those costs in its financial decisions.

6. fiduciary finance law: a conflicting rationale

In addition to the foregoing limitations of the rationales of SRI as a means of promoting sustainability, each collides with an alternative model of investing provided by fiduciary law. As will be explained shortly, each SRI rationale can meet the fiduciary law expectations only by jettisoning some of its pretentions to social responsibility. If the SRI movement is to attract more adherents, it needs more than just compelling ethical or economic theories to motivate investors: it also needs to understand and overcome the fiduciary finance law context. The legal framework for investing and SRI itself transcends fiduciary law, drawing on a mosaic of controls that commonly include corporate governance, securities regulation and contract law. But the fiduciary law context is the principal influence on the latitude for SRI in the context of institutional funds that now dominate financial markets, and it is the focus of the following discussion.

Fiduciary law, a tradition of common law systems, disciplines how a person with discretionary control over the affairs or assets of another party behaves. Fiduciary law has acquired importance in our era of global institutional investment where large pools of money are managed by pension plans, insurance companies, foundations and other institutions on behalf of their numerous beneficiaries. The hallmarks of a fiduciary relationship are ‘the scope for exercise of discretion or power by the fiduciary, the ability of a fiduciary to affect the legal or practical interests of the beneficiary and the vulnerability of the beneficiary’.^{Footnote 71} A fiduciary relationship centres on the duty of loyalty, requiring the fiduciary to act in the beneficiaries’ sole or best interests and in accordance with the purpose of the particular fund.^{Footnote 72} Fiduciary status in investment management is frequently associated with trust relationships, such as a pension fund trust, in which an ancillary set of trust law obligations arise, which include prudent investment. The duty of prudent investment is substantiated in the expectation of adherence to investment conventions such as maintaining a well-diversified portfolio of assets and seeking optimal risk-adjusted financial returns. Somewhat functionally similar legal arrangements established by financial regulation and contract law exist in civil law jurisdictions.^{Footnote 73}

The seemingly exclusive focus of fiduciary law on the interests of investors, especially their financial interests, potentially clashes with any vision of SRI prioritizing environmental and social responsibility.^{Footnote 74}Some British court rulings^{Footnote 75} suggest that trust funds are liable to their beneficiaries if they sacrifice financial returns for ethical causes. Fiduciary duties were first seen as a hindrance to SRI in the 1980s South African divestment campaign.^{Footnote 76} Many academic commentators view the fiduciary duty as one to act solely in the financial interest of beneficiaries^{Footnote 77} and conclude that many practices of the SRI industry are of ‘doubtful legality’.^{Footnote 78} One study warns that ‘current interpretations of the fiduciary duties of pension fund managers may unnecessarily constrain their ability to address the full range of relevant corporate responsibility considerations related to prospective investments’.^{Footnote 79}

In recent years the fiduciary prejudice against SRI has waned somewhat, not because of any legal reform but because SRI has been redefined by the financial industry as a business strategy rather than an ethical imperative. One influential report, sponsored by the UN, reflects this pragmatic sentiment, advising that ‘integrating [SRI] considerations into an investment analysis so as to predict more reliably financial performance is clearly permissible and is arguably required in all jurisdictions’.^{Footnote 80} Whereas SRI was once commonly known as ethical investment, today it is rationalized as a business case.^{Footnote 81} Even the most socially responsible public sector pension plans, such as CalPERS, stress that their primary goal is profit-making for their beneficiaries.^{Footnote 82} The United Nations Environment Programme – Finance Initiative (UNEP-FI) advises bluntly that ‘[t]he first – and arguably for investors the most important – reason to integrate [environmental, social and governance] issues is, simply, to make more money’.^{Footnote 83} This rationalization is advanced as a way to overcome the fiduciary law impediment. This perspective has importance for the UO thesis, as its central premise is that the social and environmental performance of the economy as a whole, in addition to that of individual firms, is financially material to large institutional investors.

By appealing to the market’s logic, business case SRI would seem to overcome the movement’s historic obscurity. For moral arguments to prevail among investors, it is likely that there should be some substantial preponderance of public opinion, which is difficult to attain. By contrast, financial self-interest can be a potent reason to act: vividly depicting climate change as a financial threat or opportunity can galvanize investors more than pious talk.

Yet the business case is not yet a viable basis for a comprehensive approach to SRI. One problem concerns the availability and use of ESG information in investment decision-making. Social and environmental due diligence is still far from integrated into conventional financial practices.^{Footnote 84} Several impediments to robust ESG analysis have been identified; these include scepticism about the link between ESG factors and investment performance, behavioural impediments rooted in the organizational culture of institutional funds and their agents, the difficulty of monetizing intangible ESG information, and dissatisfaction over the quality and reliability of ESG information.^{Footnote 85} Research on United Kingdom (UK) pension funds suggests that trustees often see climate integrity as too nebulous for workable financial quantification, and thus not warranting serious consideration.^{Footnote 86} By contrast, investment professionals are accustomed to ‘hard’ financial data such as return on equity, sales growth, price/earnings ratios, and other technical indicia of financial performance.^{Footnote 87} In sum, sustainability issues must be perceived to have financial implications, otherwise investors might ignore them, and any adverse financial implications may be trivialized as distant, long-term issues to which fiduciary investors are not accountable today.

A further objection to basing SRI on ‘financial materiality’ for investors is that a countervailing business case for financing environmentally damaging companies could prevail. Ubiquitous market and regulatory failures to control environmental externalities provide temptations for financiers. The recent international commodities market boom is one such example of intensified exploitation of natural resources. In other words, if SRI is contingent on profitability, that logic will also sometimes provide reasons to act unethically. While the business case for investing responsibly strengthens over the very long term,^{Footnote 88} many factors currently impede taking such a perspective: fund managers typically hired on two-year performance contracts are skewed to act myopically; corporations themselves are structured around short-term financial measurements, such as quarterly financial reporting; and uncertainty persists over the financial cost of distant environmental harms, which depends partly on the extent of government regulation to penalize polluters.^{Footnote 89}

Apart from the problems of substantiating the financial materiality of SRI, a further potential problem with the UO thesis from a fiduciary law perspective is that the benefits of SRI may not accrue exclusively or primarily to the funds’ beneficiaries. To the extent that a universal owner continues to hold a ‘universal’, diversified portfolio consistent with market norms, there should not be any fiduciary law barrier to practising SRI as long as the extra costs of ESG due diligence are offset by improving financial returns. Indeed, one could argue that there is a fiduciary duty on large institutional funds to practise SRI. The UO thesis implies that because the financial performance of investors’ portfolios is influenced by the sustainability performance of the economy as a whole, fiduciaries will remain loyal to beneficiaries when considering ESG issues. However, given the market failures just described, the UO thesis cannot be implemented easily without extensive changes to the environmental governance and practice of financial markets. (These will be discussed in the next section.) Under current market conditions, it is quite likely that a universal investor practising stringent SRI would need to sacrifice immediate investment returns. This would consequently pose a problem from a fiduciary law perspective, because the collateral benefits to beneficiaries might be too ambiguous, unquantifiable or deferred.

The leading case that helps us to understand the interface between fiduciary responsibility and the UO thesis is Cowan v. Scargill.^{Footnote 90} Trustees appointed jointly by the National Coal Board and the National Union of Mine Workers disagreed over the investment strategy for the workers’ pension plan. The union trustees wished to ban further foreign investment of the plan’s assets including, in particular, investment in energy industries competing with coal mining. In affirming that the financial interests of the direct beneficiaries of the pension fund were the paramount legal consideration, the presiding judge, Megarry V-C, rejected the argument that by restricting foreign investment and investment in energy sectors in competition with coal mining, important benefits would accrue to the British economy and thus the beneficiaries as members of that society. Megarry V-C explained:

While the Cowan ruling is not without some limitations as a judicial precedent – because of its unusual facts and a crude investment policy that ‘bore little or no resemblance to a modern ESG investment policy’^{Footnote 92} – the general conclusion of the judgment about needing to show a connection between a (UO) investment strategy and returns to beneficiaries is legally persuasive.

Similar fiduciary law difficulties confront the complicity-based doctrine and the leverage-based responsibility rationales. The former is not legally supportable unless the exclusion of unethical investments can be justified as financially beneficial to the fund, or if it is mandated by its constitution. An SRI mandate could be legally established for mutual funds marketed to retail investors through the articles of incorporation, the prospectus issued by the fund, or its governing trust instrument. While mutual funds have the flexibility to tailor investment portfolios to the ethical or financial needs of individual investors without the same degree of fiduciary law constraint imposed on many other institutions, their capacity to promote credible SRI is weakened by an organizational culture obsessed with short-term returns and competitive advantage.^{Footnote 93} An SRI mission may also be prescribed for a charitable fund, which commonly takes the form of an investment foundation managed by a board of trustees, and it may be associated with universities, environmental organizations and community groups.^{Footnote 94} Unlike other forms of SRI, which typically have a more multi-dimensional scope, these ‘mission-based’ investors tend to focus narrowly on a few issues connected with the specific charitable purpose at hand. For example, a fund associated with an organization that sponsors medical research into fighting cancer might be concerned only with avoiding tobacco companies. And it would be legally problematic for a mission-based investor to eschew investments on ethical grounds that do not relate to the purpose of the charitable fund, especially if such decisions would be financially imprudent.

Furthermore, the increasing preference of the SRI industry for corporate engagement rather than divestment as its primary means of influence is at odds with the exclusionary stance of the complicity standard. Corporate engagement not only allows for a financially advantageous diversified portfolio^{Footnote 95} – an outcome aligned with the fiduciary standard – but the activity of engagement itself, such as filing or supporting shareholder resolutions, is increasingly viewed as relevant to fiduciary responsibility. The United States (US) Department of Labor has advised that shareholder rights are valuable fiduciary assets that should be utilized by pension fund managers in the interest of beneficiaries.^{Footnote 96}

Otherwise, a legislative mandate to practise complicity-based SRI is required. This is provided only in limited circumstances in a few jurisdictions. Norway is one example, as cited earlier in this article. It is also found in the legislation for the New Zealand Superannuation Fund (NZSF), the trustees of which must prepare a policy on ‘ethical investment … for avoiding prejudice to New Zealand’s reputation as a responsible member of the world community’.^{Footnote 97} This deontological ethical duty to ‘avoid prejudice’ has been interpreted by the NZSF trustees to justify the exclusion of entities involved in whaling, the manufacture of tobacco products, cluster and anti-personnel mines, and the production and testing of nuclear explosives.^{Footnote 98} Another pertinent example of an explicit waiver of ordinary fiduciary principles based on the complicity standard is Ontario’s former South African Trust Investments Act 1990, which allowed divestiture from South African investments even if such action might hurt financial returns. The Act absolved trustees from their fiduciary and other legal duties as long as they had consulted with beneficiaries and had at least the support of the majority.^{Footnote 99} Like the New Zealand and Norwegian approaches, the Ontarian statute (now repealed) is couched in negative terms, indicating that a trustee will not breach fiduciary duties by considering non-financial factors, rather than creating a positive duty on trustees to invest ethically and to promote sustainable development.

The leverage-based responsibility standard for SRI also potentially sits askew from fiduciary law. On the one hand, the expectation that investors should use their leverage to influence companies, such as through the exercise of shareholder rights, could reinforce fiduciary responsibility where this can improve financial returns. Otherwise, expecting financial institutions to ‘police’ the market’s social and environmental behaviour would be beyond how such entities view their economic function and legal responsibilities. Some emerging SRI codes of conduct, such as the Equator Principles^{Footnote 100} and the UNEP Statement by Financial Institutions on the Environment and Sustainable Development,^{Footnote 101} imply some modest supervisory role as part of financial institutions’ due diligence and social licence, and with time these voluntary codes could help to substantiate new investment management protocols supportive of the leverage-based standard. However, the public interest conscience implied by leverage-based responsibility currently has little traction in fiduciary finance law, which remains focused on serving the interests of private beneficiaries rather than concomitantly accommodating some amorphous ‘public interest’. Consequently, the capacity of SRI to govern for sustainability is limited by the undergirding role that fiduciary law plays in defining the parameters of acceptable financial practices by institutional funds.

7. an alternative sri rationale and fiduciary standard for long-term investing

If SRI is to thrive and become more influential in the market, it must more cogently articulate the symbiotic relationship between the sustainability of the economy and those who invest in it. Because ecological systems function over indefinite time horizons, valuing the future is essential. It is not good enough simply to eschew companies that morally offend (as in the complicity-based doctrine) or seek to change their behaviour only when an individual investor has influence (as in leverage-based responsibility). These approaches leave unaddressed the importance of promoting sustainable development and fail to consider how a fund’s beneficiaries may benefit in the long term from a socially responsible stance even if the fund cannot change the behaviour of others today.

The UO thesis better recognizes the financial materiality of environmental and social issues compared with other SRI rationales, but it has some limitations, including its focus on very large institutional funds (rather than investors generally), its emphasis on the spatial, economy-wide scale of investing (rather than its temporal scale over the long term) and its failure to take seriously the need to address systemic market failures to safeguard the environment. While proponents of the UO thesis certainly refer to the importance of investors taking a long-term perspective, they do not elaborate how such a perspective can be achieved and the barriers to overcome. The UO thesis captures the long-term orientation mainly indirectly as a criterion for managing costly externalities, though the challenges to overcoming the discounting of future costs and benefits and other market failures are largely glossed over. Tellingly, the SRI industry’s most widely ratified code of conduct designed explicitly for universal owners, the 2006 UNPRI, omits any reference to a ‘long-term’ approach in its key six principles, even though the UNPRI preamble declares that institutional investors ‘have a duty to act in the best long-term interests of [their] beneficiaries’.^{Footnote 102}

Investing for the long term provides a conceptually clearer benchmark for financial institutions. It provides a better assurance for taking into account environmental externalities because such costs may be latent and often do not fully manifest for many years. A long-term approach also requires an emphasis on both avoiding harm and promoting good. A far-sighted outlook could also mitigate impatience and thus foster more careful and diligent decision-making.^{Footnote 103} And it is not always necessary to define ex ante the temporal period covered by ‘long term’; the sustainability paradigm mitigates the perceptual barriers people face in valuing the future over some indeterminate time frame or conceptualizing the needs of posterity. Its focus is to maintain core ecological services and functions now, and keep depletion of renewable resources within sustainable harvest rates. Part of that sustainability agenda also requires greater understanding of the past in order to save the future. If sustainability is merely measured against the state of the environment today it may fail to assure enduring ecological health, given so much previous pollution and resource depletion. In framing baseline conditions to guide investing for the long term, it is thus important also to have a programme of positive investment for the restoration and rehabilitation of damaged landscapes.

On the other hand, social issues such as respect for human rights and poverty alleviation, which are also issues for some social investors, are not as easily accommodated within the financial tools and metrics of financial markets and are perhaps better addressed through more traditional legal approaches. This article has already explained why the priority must be to focus on the environmental sustainability agenda of SRI, at least initially. In any event, ensuring that development respects ecological parameters should, in turn, improve social welfare and respect for human rights. Many unabated environmental problems, such as pollution, can engender social injustices when the poor or marginalized bear the brunt of the harm.

Though there are incipient tendencies in the SRI industry towards this temporal shift to long-term sustainability – evident in the establishment of prescient investor groups such as the UK-based Marathon Club^{Footnote 104} and the French-based Long-Term Investors Club^{Footnote 105} – significant barriers to marathon investing remain, as already partially outlined in this article. Planning over decades defies the normal outlook of most investors and, indeed, is beyond most types of institution or individual. Short-termism and impatience is rife in global financial markets. The fetishistic focus on short-term performance may involve inflating current profits at the expense of the long-term health of a fund or firm, or using short-term trading tactics that ignore the underlying value of businesses.^{Footnote 106} One potent indicator of short-termism is the high turnover of corporate securities: the average holding period for shares listed on the New York Stock Exchange has plunged from about seven years in the 1940s to just over five years in 1970 and down to six months in 2009.^{Footnote 107} Further evidence of myopic habits is contained in the UK government’s seminal ‘Kay Review of UK Equity Markets and Long-Term Decision-Making’.^{Footnote 108} Significantly, these trends towards short-termism have generally coincided with the growth of institutional investing, directly contrary to the expectations of the UO thesis. These impatient investors may suffer financially over the long term through ‘decreasing market efficiency, reducing investment returns, and impeding efforts to strengthen corporate governance’.^{Footnote 109} Such findings are in addition to the costly depletion in natural capital that may not be fully accounted for until many decades have passed.

The challenge is to elaborate the conceptual and legal framework and practical tools to guide and operationalize investing with a long-term outlook. The current divergence between the business and ethical case for sustainability is a significant impediment for SRI practice, but is mainly one in the short term; with enough time, they should converge. Shifting the market towards an enlightened, long-term focus could be substantiated by the sustainability paradigm, a framework for indefinitely safeguarding ecological integrity and a healthy biosphere.^{Footnote 110} A substantial body of norms and procedures on sustainability has evolved in the area of environmental law and policy that could help to encourage its application to the financial economy.^{Footnote 111} For example, the legal concept of the precautionary principle could help with the appraisal of economic activities that pose uncertain risks but potentially irreparable environmental harm. However, additional specific measures are needed that are tailored to financial markets and the fiduciary law context.

The SRI industry and legal reformers must focus on procedural standards rather than disciplining rigid adherence to specific performance outcomes, because a sustainable investment portfolio depends on many variables and contexts. In legal terms, the pathway to inculcate this new direction is through the prudent investing standard of fiduciary and trust law, which is informed mainly by the collective market practice rather than legislative prescription. So far, that market has egregiously herded investors towards a limited range of unimaginative practices out of fear of being seen as unorthodox and thus risking liability. As Keith Johnston and Frank de Graaf explain, ‘what functioned as a “prudent expert” fiduciary standard 30 years ago has become more of a “lemming standard” that increases the severity of booms and busts and discourages adoption of improved practices that are not yet used by peers’.^{Footnote 112} A different market convention that underpins a more socially responsible view of ‘prudent’ investing is needed. Essentially, ‘prudence’ must mean extensive environmental due diligence, appropriate valuation of future costs and benefits, and more selectivity in the composition of investment portfolios, with a view to long-term financial performance and sustainability.

In turn, a reformulated notion of prudent investing can help to disarm concerns that SRI does not directly and materially benefit financial beneficiaries, as raised by the Cowan case. Fiduciary law already recognizes that the duty of loyalty owed to beneficiaries does not exclude providing collateral benefits to others, such as would be the case in the promotion of sustainable development: the standard is usually framed to act in their best interests, as against their sole interests.^{Footnote 113} The underlying fiduciary and trust law standard of prudent investing could also, to some extent, evolve flexibly in response to the ensuing shift in the best practice conventions of the market. As the American Law Institute’s authoritative restatements on trusts law enjoin, ‘[t]rust investment law should reflect and accommodate current knowledge and concepts. It should avoid repeating the mistake of freezing its rules against future learning and developments’. ^{Footnote 114} As it becomes recognized that prudence requires investing in sustainability, fiduciary law in turn can reinforce the collective market practice. Yet, given the entrenched market attitudes and practices that militate against such change, legislative intervention to codify and clarify the parameters of fiduciary responsibility is probably necessary in order to behove fund managers and trustees to practise SRI. For instance, legislation governing pension funds could stipulate that fiduciary responsibility must be measured not merely against near financial returns but also weighted to take account of best environmental practices.

Several specific building blocks to creating this new fiduciary ethos of prudent investing should be introduced.

1. (1) There must be far greater SRI research into the economic value of ecological services and resources, and public–private partnerships to sponsor such research must be forged to counter the risk of industry bias.

2. (2) Financial accounting and reporting must use appropriate discount rates that do not undervalue long-term environmental costs and benefits, and such information should be incorporated into the valuation of financial assets.

3. (3) Decision-making within the financial industry must be more transparent and inclusive to enable new perspectives. Revised investment protocols that steer markets towards the long term should be developed in collaboration with other societal stakeholders, such as environmental organizations, trade unions and the state. Some emerging collaborative investor networks operating transnationally that could be harnessed for this purpose are UNEP-FI, as noted earlier in this article, and the Coalition for Environmentally Responsible Economies (CERES).^{Footnote 115} Such initiatives would strengthen the putative ‘global administrative law’ character of SRI standards and protocols, which are important in order to compensate for the deficits in the reach of national fiduciary law beyond state borders. The voice of non-investor groups must be included in order to ensure that public interest considerations are incorporated.

4. (4) Governments should manipulate the economic incentives for acting in the long term, such as through taxes on short trading in corporate securities and capital gains tax deductions for patient investors.

5. (5) Public sector financial institutions such as sovereign wealth funds should show leadership in forging new SRI approaches that emphasize the long term through positive investment in sustainable development. In a transnational economy, sovereign wealth funds such as the Norwegian and New Zealand funds noted earlier in this article are best placed to revamp their SRI legal mandates to play this leadership role.

Helpfully, the foregoing strategies do not require rigid prescriptive judgments on what a sustainable future looks like, but provide tools to nudge investors towards it.

The main task to resolve within fiduciary law would be how to judge whether a financial trustee has behaved appropriately when the impacts of today’s decisions may not become apparent for many decades. In other words, how can we judge now whether a fund is acting correctly over the long term? One response would be for fiduciary law to enshrine prophylactic rules such as duties to consult, undertake research and make informed decisions that are likely to be conducive to long-term investing. In other words, compliance with fiduciary finance law would be demonstrated by adherence to procedural standards of due diligence. This would help to overcome the problems encountered in the Cowan case of how to quantify the relationship between investing socially and the financial interests of beneficiaries.

The foregoing recommended shift towards long-term and patient investing would not necessarily entail jettisoning entirely the other rationales for SRI canvassed in this article. Indeed, the long-term outlook could provide an additional layer to them, with each rationale guiding more specific and nuanced investor action, such as eschewing investments that may be ecologically sustainable but nonetheless still morally questionable for a given individual who does not wish to be ‘complicit’. However, the existing rationales could not necessarily always stand untouched from the perspective of promoting sustainability. With regard to the UO thesis – which has the narrowest conceptual distance from the approach advocated in this article because it also recognizes the financial materiality of environmental performance – it is not good enough simply to advocate long-term investing when the UO thesis assumes that institutional investors are and will remain broadly diversified across the entire economy (as ‘universal’ investors). Instead, a long-term investor may need to shun some sectors, thereby becoming a ‘sectoral’ investor who focuses on supporting a narrower range of sustainable and responsible businesses. Many fossil fuel industries, for example, might have no place in the portfolio of a sustainability-focused investor.

In sum, the foregoing argument sketches an alternate rationale and amended legal framework for SRI that arguably is more isomorphic with the environmental sustainability agenda. Moving in this direction, however, requires an equally critical assessment of the limitations of the existing rationales for SRI, as this article sets out. The UO thesis is an important innovation in making SRI more relevant to the environmental challenges facing the global economy, offering a more comprehensive approach to such challenges than that of other SRI rationales. However, the thesis has structural limitations that are best overcome by adopting a clearer temporal orientation to SRI coupled with supportive fiduciary and procedural reforms of the governance of investing.