Does the law support investing for sustainability impact?

Following the IPCC’s ‘code red’ report, COP26 marks a crucial moment in governmental attempts to tackle climate change. Here, we explain how our research is helping to advance legal and policy thinking around two of the UN climate summit’s four pillars – ‘mobilizing finance’ and ‘collaboration’

The question of how to move capital from activities that damage the climate towards those that can help to protect it has been the subject of intense debate. Trillions of dollars are needed to finance the transition to a low-carbon economy and, while ‘sustainable finance’ and ‘ESG investing’ have grown in recent years, it’s unclear how much difference they’ve yet made in tackling this challenge.

Against this backdrop, Freshfields recently published A Legal Framework for Impact (commissioned by the UN Environment Programme Finance Initiative, the UN-supported Principles for Responsible Investment, and the Generation Foundation), its second major study looking at the role the law plays in sustainable investment. The first – the 2005 Freshfields Report – helped dispel the myth that there were legal barriers to investors taking ESG factors into account in their investment decisions where material to the financial performance of those investments, and provided a basis for the subsequent explosive growth of ESG integration in investment practice.

Why ‘A Legal Framework for Impact’ matters

A Legal Framework for Impact examines whether the law in 11 key investment hubs around the world permits or requires investors to go further – that is, to intentionally seek to influence their investee companies, policymakers and other third parties in ways that improve environmental and social sustainability outcomes in assessable ways. The report refers to this sort of activity as investing for sustainability impact.

Environmental sustainability is a core social goal and can only be realized via the alignment of multiple actors across social and economic systems. Investors are part of those systems and their potential to drive higher sustainability performance is therefore of keen interest to those on whose behalf they invest, as well as to policymakers and beyond. Investors’ role in influencing sustainability outcomes is also important because, in many cases, their ability to achieve their own financial return goals relies on the sustainability of the environmental and social systems on which their investee companies depend to flourish.

As a result, it’s essential for investors to understand how these concerns regarding broader systems relate to their own legal responsibilities.

What are the report’s main findings?

A central conclusion of A Legal Framework for Impact is that where a sustainability risk bears on an investor’s legal duties to pursue financial goals – and where investing for sustainability impact can be effective in addressing the relevant risk, investors will likely be required by law to consider using sustainability impact approaches and to act accordingly.

However, the report cautions that the circumstances in which investors can pursue positive sustainability impacts as an end itself, such as progress on climate change, may be limited. If policymakers are keen for institutional investors to be able to provide the levels of finance necessary to achieve, for example, the goals of the Paris Agreement, they may need to intervene to change the law to facilitate investors’ ability to direct their investments in that way. Indeed, the issue may be particularly acute in the case of capital allocation.

That said, there are instances in most jurisdictions where investors are permitted by law to pursue sustainability goals for their own sake in parallel with financial goals, usually subject to prioritizing financial goals. With growing evidence that many individual investors want those managing their investments to take this sort of purposeful approach, understanding the legal position around such activity is critical.

How might an investor approach seeking to achieve a sustainability impact in support of its financial goals?

In public markets it’s unlikely that an investor acting alone and using only the power of its investment decisions only would have sufficient influence to make a difference in this regard. This is leading many investors to focus instead on stewardship and/or public policy engagement, and to do so collectively. That said, it is reasonable to suppose that a group of investors acting together who hold a substantial portion of the securities of relevant investee enterprises – or who propose to invest at scale – could drive higher sustainability outcomes through their investment decisions. Because of this, A Legal Framework for Impact looks closely at the possibility of collective action between investors and other third parties, and the way in which legal duties may need to be understood and applied, not just individualistically, but also by reference to the collective whole – potentially offering a route to the sort of system-wide response needed to tackle systemic sustainability risks.

What does the report mean for investors – and for business?

Looking ahead, we hope the report will lead investors to consider whether they should be investing for sustainability impact, which in turn would drive greater focus on the impact their investees are having on the sustainability factors they care about, including climate change. The need for investees to provide information on their performance in these areas (alongside what they already disclose around the sustainability risks they themselves face) looks set to grow, and we might also anticipate investors supporting public policy moves to tackle sustainability challenges as a means of addressing systemic issues that impact their entire investment portfolios.

For more information about A Legal Framework for Impact, including a link to the report itself, visit the Freshfields website here. If you’re interested in discussing how its conclusions might affect your business, please reach out to any of us and we’d be happy to arrange a meeting. If you’re keen for more insights on COP26 and climate issues more broadly, explore the Freshfields Climate Hub. You can find out more about the UN Environment Programme Finance Initiative here, the Principles for Responsible Investment here, and the Generation Foundation here.

Authored by David Rouch, Juliane Hilf, Timothy Wilkins and ‘A Legal Framework for Impact’ Project team