Incorporate ESG: a legal checklist

Dentons Kensington Swan partner David Ireland warns of greenwashing when implementing ESG.

Wednesday, March 23rd 2022, 8:12AM

by Jenni McManus

Trustees of workplace savings schemes who plan to include ESG considerations in their investment decisions must comply with a raft of statutory and other duties to avoid falling foul of the regulator.

That’s according to David Ireland, a partner at Dentons Kensington Swan, who also warns that the issue of ‘greenwashing’ – making false or misleading claims that a company’s products are environmentally friendly when they’re not – is “squarely on the FMA’s radar”.

Ireland, who is the convenor of the Financial Services Council’s Workplace Savings Committee’s training focus group, told those attending an FSC webinar last week that trustees must ensure the information they’re disclosing to scheme members is correct and that they’re not being hoodwinked by greenwashing.

“Make sure you’re walking the talk – that you can substantiate any claims you’re making about your approach to ESG,” he said. “It all comes down to ‘are we [being]misleading or misrepresenting the nature of the scheme’s investments?’ It comes down to doing your homework and making sure you’ve got your systems in place.”

Komal Jalan, the Sydney-based leader of Mercer Fund’s Pacific region sustainable investment function, says greenwashing is a “massive issue” and investors need to “look beneath the hood” to ensure what an organisation’s marketing people are claiming is actually true. “If a fund is calling itself ‘100% fossil-fuel free’, is that even possible?”

Over the past 10 years, ESG (environment, social, governance) and SRI (socially responsible investing) considerations have become mainstream. A decade ago, Ireland says, this wasn’t the case: it was an open question as to whether it was prudent to put an SRI filter across investment decisions. He himself wondered if it was sensible for trustees to limit their decision-making in such a way and still discharge their responsibilities as prudent trustees.

Now, Ireland says, the dial has completely flipped. “If you’re not thinking about SRI/ESG considerations, are you actually being prudent?”

He likens the change in investor sentiment to the journey the financial services industry went through in the 1990s with passive versus active investments. Active investing got the nod but “now, there’s a very strong argument from some sectors saying ‘passive’ is the only logical thing and questioning whether ‘active’ is an appropriate strategy,” Ireland said.

“I see SRI/ESG is a very similar camp although I think the dial has flipped more towards thinking that as a trustee your responsibility must involve you thinking about ESG [and whether] it makes sense within the context of your scheme.”

Jalan says millennials, in particular, expect their funds and trustees to have a stance on ESG. “Not being seen to be doing that could be reputationally damaging,” she says. These investors tend to be motivated by three key things: a belief that ESG considerations will lead to better returns; their investment decisions should align with their personal values (these investors also see themselves as stewards of the assets entrusted to them); and a desire for their investments to make a measurable and positive impact.

The legal framework
The basic law for trustees is the Trusts Act 2019 with its broader definition of what it means to invest prudently. Trustees must also follow the rules set out in the trust deed to ensure they’re following the correct process if they’re planning to change their investment strategy to incorporate considerations such as ESG/SRI, Ireland says, “though it would be a very unusual trust deed that said you could not embark on an SRI strategy”.

The Financial Markets Conduct Act also comes into play as it contains the broad statutory duties trustees need to discharge when thinking about their approach to ESG.

“As trustees of a workplace savings scheme – and any retail scheme operating in New Zealand – you have a statutory duty to act in the best interests of your scheme’s participants,” Ireland says. “Also, when exercising any power of investment, you must exercise the care, diligence and skill that a prudent person of business would exercise in similar circumstances, with an extra layer if you are a professional trustee.

“So, the question to ask is ‘is ESG, or your approach to ESG, in the best interests of your members and a prudent thing for you to do?’”

In a workplace environment, a belt-and-braces approach might include surveying scheme members to ensure they’re comfortable with an ESG filter, recognising that, unlike retail investors, those with their funds in workplace savings schemes don’t have the opportunity of voting with their feet. Trustees need to demonstrate they’re acting in the best interests of participants so they should document their rationale for choosing an ESG approach and record all their decisions and the reasons for them. Disclosure to participants should flow through into the scheme’s investment policy and objectives.

There are other statutory filters to consider – for example, the ban on investment exposure to cluster munitions and chemical weapons. And, on Friday 18 March, the Russian Sanctions Act and regulations kicked in, banning (among other things) any dealings with companies, entitles, services and people named on the government’s blacklist of those with links to Russia’s invasion of Ukraine or people and entities of strategic or economic important to Vladimir Putin.

So, New Zealanders and New Zealand entities are now prohibited from dealing with assets and services that are owned or controlled by anyone on the blacklist. Those who were holding Russian assets prior to the law taking effect will not be in breach by continuing to hold them so long as there is no further dealing (most are illiquid and have lost considerable value since the invasion).

However, if a sanctioned Russia person or entity owes you an obligation, that can still be paid out, Ireland says. “This is a major shift for New Zealand and we’re still digesting what the implications will be.”

Tags: ESG