Fiduciary duties of pension fund managers in the anthropocene
The latest report by the International Panel on Climate Change (IPCC) estimates that hundreds of billions of dollars will be required for climate mitigation and adaptation investments per year to avoid catastrophic global warming. Yet, some of our financial practices are not only slow to adapt to this requirement, but actually represent an obstacle in achieving the goal.
Put simply, tipping the financial balance in favour of greener investments has two components: On the one hand, investing in green energy and emission-reducing technologies such as insulation and filters; on the other hand, cutting funding for fossil-fuel intensive sectors. The latter can be divided into a number of subtasks: stopping subsidies to the fossil-fuel sector; forcing the sector to pay for the environmental externalities it generates and that it currently passes on to society at large; and disincentivizing private investment in fossil-fuel intensive activities, through carbon taxes for instance.
Public policy thus far has focused on boosting green energy, but woefully lags behind when it comes to cutting back investment for greenhouse-gas-intensive industries. One way in which many people knowingly or unknowingly contribute to this inertia is through their pension funds. While some sovereign wealth funds and other financial players of various sizes have divested from fossil fuels, pension funds that have done so are few and far between.
The reason for this lies in the way that pension funds are regulated in many countries. Administrators of these funds have a fiduciary duty to serve the interests of fund members. So far, so plausible. The problem lies in the way this fiduciary duty is spelled out and interpreted. Consider article 60 of the Pension Benefits Standards Act of the province of British Columbia, Canada: “Investments, including loans, and financial decisions respecting a pension plan must be made (a) in accordance with this Act and the regulations, and (b) in the best financial interests of plan members and other persons entitled to benefits under the plan.” (my underlining)
In short, this narrow interpretation of the fiduciary duty of pension fund managers not only permits them to put financial interests over any other considerations, including climate change, but it requires them to do so.
The economic case for taking climate change more seriously
Those who believe in the efficiency of financial markets will interject at this point that, contrary to my claim, there is no real tension between financial consideration and climate imperatives. After all, financial markets price in declining profits for the fossil fuel sector already.
The problem with this argument is twofold. First, financial markets only anticipate such trends to the extent that we are actually committed to holding the fossil fuel sector accountable for the environmental externalities is causes. As mentioned earlier, we currently do not do that. As a consequence, fossil fuel extraction is inefficiently high and more profitable than it would be if priced appropriately. Second, as financial regulators such as Mark Carney and other top central bankers acknowledge, financial markets systematically fail to price in the possibility of sudden losses in fossil fuel assets. Pension funds, among others, therefore run the risk of being left with stranded assets.
The ethical case for reinterpreting fiduciary duties
Based on the economic case alone, it seems tempting to conclude that it might be sufficient to reduce exposure to fossil fuel assets by more than standard financial models recommend. This, however, would miss a more fundamental problem. While it might have been appropriate 50 years ago to equate the interests of pension fund members with their financial interest, doing so today is paternalistic and hard to justify.
If climate change mitigation is a priority for the members of a pension fund and if they value it enough to sacrifice some financial return, then the narrow interpretation of fiduciary duties used in places such as British Columbia is problematic. It is their money and they should be able to define their interests in how to manage it themselves.
Reform options
What can be done to turn pension funds from an obstacle into a vehicle of climate change mitigation? Here are two basic options. First, we could make pension funds more democratic by giving members a voice in determining the strategy of their fund on certain important issues such as climate change. For instance, members could vote on divestment proposals or emission reduction targets for their portfolio, thus given their fund administrators a mandate to pursue these goals.
The second option is to require pension funds to give their members a choice between funds with different investment profiles. As a member, you would be able to choose, for example, between a fully diversified fund on the one hand, and a fund that excludes certain assets such as tobacco, arms, pornography, private prisons, and fossil fuels on the other hand. Recent regulatory changes have moved the Australian pension system in this direction.
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For an article that deals with some of the issues raised in this piece in more detail, see Peter Dietsch, “Exit versus voice – options for socially responsible investment in collective pension plans”, Economics & Philosophy 36/2 (2019): 246-64.
