By Simon O’Connor
CEO, Responsible Investment Association of Australasia
As interest in impact investing continues to surge forward, two important pieces of research have helped to flesh out both the current scale of capital flowing into impact investments as well as the future trajectory of capital in these important investment strategies.
In July, RIAA released the Responsible Investment Benchmark Report 2016, showing investors’ growing appetite for social and environmental impact products. Secondly, Impact Investing Australia’s 2016 Investor Report launched in March – in collaboration with RIAA – highlighted that this area has plenty of wind in the sails, with an estimated $18 billion of investor demand over the coming 5 years.
For this wave of capital to be unleashed, particularly to harness the scale of institutional capital, many elements need to now come together. In particular, if we are to see superannuation funds’ capital being put further to work in impact investments, we require further clarity from Australian Prudential Regulation Authority (APRA) on trustees’ fiduciary duties.
What we know from super funds and other investors in impact strategies is that from an institutional investor perspective, such investments have been strongly complimentary to a long term investor’s portfolio. To date, decisions by super funds to invest in impact investments have been driven by a clear appraisal of the investment’s abilities to deliver commensurate financial returns as well as a determination that those investments will be supportive of the broader portfolio objectives. That these investments deliver measurable social outcomes of a kind that is strongly supported, and increasingly demanded, by members, has offered an opportunity to deliver a clearly positive investment that ticks all boxes.
However, current APRA guidance to superannuation fund trustees remains confusing when it comes to issues of responsible investment, environmental, social and corporate governance (ESG), ethics and impact investments. Without further clarity, this confusion risks holding back the growth of impact investing.
The relevant Prudential Practice Guide (SPG 530) notes that ESG considerations and ethical investments are consistent with a trustee’s duties as long as any such investments are in the best interests of beneficiaries and do not expose the beneficiary to undue risk such as lack of liquidity or diversification. Other factors – read impact, ethics or ESG – may be considered where there is no conflict with these requirements.
With approximately half of all professionally managed assets in Australia now implementing a responsible investment approach, including ESG integration, it is clear that we are now at a stage whereby the arguments over whether ESG is a financially material investment risk are over.
However, as much as we’d like this to be the case, we know that in trustee board rooms, debates still occur at times over whether these strategies are consistent with their fiduciary duties. We continue to hear from super funds that there is a hesitancy from trustees to take the next step in impact investing, or ethical screening, due to a lack of clarity as to how that guidance applies when extended into these strategies that aren’t explicitly explained in the guidance. The rapidly evolving strategies that encompass exclusions and impact investments have become challenging for some trustees to work out where they sit, particularly as these responsible investment styles are often evolving faster than regulation.
This is not only an issue for Australia, but has also been noted as a confusing area in other countries, resulting in regulators or equivalent bodies providing additional clarity specifically for the application to ESG, ethical investing and impact investing.
In 2015, the US Department of Labor updated its guidance to trustees of pension plans to confirm that fiduciaries may invest in “Economically Targeted Investments” (defined as socially responsible investment, ESG investment and impact investment) so long as this is appropriate for the plan and economically and financially equivalent with respect to the plan’s investment objectives, return, risk and other financial attributes. In calling out impact investment explicitly, this sets a very useful and clear test for how these investments can fit within a pension fund trustees’ considerations.
The UK Law Commission undertook a review of the fiduciary duties of investment intermediaries in 2014 – a recommendation of the UK’s Kay Review – concluding that trustees should take into consideration factors which are financially material to the performance of an investment and this should include ethical and ESG factors where trustees deem these to be material.
The commission also usefully concluded that the law permits trustees to act on non-financial factors providing that they have good reason to think beneficiaries share those concerns and that there is no risk of significant financial detriment, thereby offering clear and useful tests for implementing ethical and impact investment strategies
Neither the US nor the UK updated guidance has provided any earth shattering changes to regulatory environments, but by clarifying unambiguously, these have both removed an important barrier that can unlock capital towards responsible investment across all styles, including impact investments.
For these same reasons, a number of Australian industry bodies – including RIAA and Impact Investing Australia – are currently seeking greater clarification from APRA around these same issues, to put to bed any confusion that (mistakenly in our view) remains.
This clarification will help to free up the flow of capital into impact investment strategies at a critical time, just as the Australian public begins to engage more actively with super funds and to push for their retirement savings to contribute to greater social and environmental impact.