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REVIEW OF THE APPLICATION OF

ENVIRONMENTAL, SOCIAL AND

GOVERNANCE PRINCIPLES TO

TERRITORY INVESTMENT PRACTICES

29 June 2007

Prepared by the

Independent, Non-Executive Members of the Finance & Investment Advisory Board

Review of the Application of Environmental, Social and Governance Principles to Territory Investment Practices

Finance & Investment Advisory Board June 2007

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Report prepared by the:

Independent, Non-Executive Members of the Finance & Investment Advisory Board

Those Members being:

Barbara Yeoh Ken Searson

Phillip Charley

29 June 2007

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Disclaimer: This report has been prepared by the Australian Capital Territory Government’s Finance and Investment Advisory Board (the Board) at the request of the Chief Minister’s Department. This Report is solely based on information provided by third parties, including Frontier Investment Consulting and the Department of Treasury, and information in the public domain. No warranty of accuracy or reliability is given in relation to information and documentation provided by those parties or in the public domain. The Board will not be liable for the consequences of any party that acts on the information supplied herein. Any reliance placed is that party’s sole responsibility.



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Contents: 1. Executive Summary ................................................................................................................................... 5 2. Terms of Reference .................................................................................................................................... 9 2.1 Process................................................................................................................................................... 9 2.2 Exclusions............................................................................................................................................ 10 3. ACT Government (Territory) Investments ............................................................................................... 11 3.1 Superannuation Provision Account (SPA) .......................................................................................... 11 3.2 Territory Banking Account (TBA) ...................................................................................................... 12 4. A Brief History of Ethical Investment, SRI and ESG............................................................................... 13 4.1 Recent Developments .......................................................................................................................... 13 4.2 United Nations Global Compact.......................................................................................................... 15 4.3 The “Freshfields Report”..................................................................................................................... 16 4.4 United Nations Principles for Responsible Investment ....................................................................... 21 5. What’s Happening in Australia Today? .................................................................................................. 24 5.1 Commonwealth Government’s Parliamentary Joint Committee on Corporations and Financial Services ........................................................................................................................................................... 24 5.2 Australian Stock Exchange.................................................................................................................. 25 5.3 Australian Council of Super Investors................................................................................................. 26 6. Investment Decision-Making Framework ............................................................................................... 27 6.1 Territory Investments – SPA and TBA ............................................................................................... 27 6.2 Investment Decision-Making Framework for Other Types of Institutional Investments.................... 28 6.3 Case Law ............................................................................................................................................. 29 7. Terms of Reference #1 ............................................................................................................................. 31 7.1 Values-Based....................................................................................................................................... 31 7.1.1 Negative Screening.......................................................................................................................... 32 7.1.2 Best of Sector or Positive Screening ............................................................................................... 32 7.1.3 Advantages and Disadvantages of Screening .................................................................................. 33 7.2 Risk-Based........................................................................................................................................... 34 7.2.1 Voting .............................................................................................................................................. 34 7.2.2 Risk-Based Engagement.................................................................................................................. 35 7.2.3 Advantages and Disadvantages of Engagement .............................................................................. 37 8. Terms of Reference #2 ............................................................................................................................. 39 8.1 Other Government Jurisdictions.......................................................................................................... 39 8.1.1 Australian Government - Treasury .................................................................................................. 39 8.1.2 Australian Government – Finance & Administration...................................................................... 40 8.1.3 New South Wales Government ....................................................................................................... 41 8.1.4 Queensland Government ................................................................................................................. 41 8.1.5 Victorian Government ..................................................................................................................... 41 8.1.6 Western Australian Government ..................................................................................................... 42 8.1.7 Northern Territory Government ...................................................................................................... 43 8.1.8 New Zealand Superannuation Fund ................................................................................................ 43 8.2 Member Investment Choice Options................................................................................................... 44 8.2.1 ARIA (formally the CSS and PSS Boards) ..................................................................................... 44 8.2.2 VicSuper .......................................................................................................................................... 45 8.3 Institutional Investors .......................................................................................................................... 46 9. Terms of Reference #3 ............................................................................................................................. 49 9.1 Background.......................................................................................................................................... 49 9.2 Australian Experience ......................................................................................................................... 50 10. Terms of Reference #4 ......................................................................................................................... 55 10.1 Values-Based Implementation Issues .................................................................................................. 55 10.2 Risk-Based Implementation Issues...................................................................................................... 57 10.2.1 Voting Implementation Issues ......................................................................................................... 57 10.2.2 Risk-Based Engagement Implementation Issues............................................................................. 58



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11. Terms of Reference #5 ......................................................................................................................... 59 11.1 Values Based Implementation Issues .................................................................................................. 59 11.2 Risk-Based Implementation Issues...................................................................................................... 60 11.2.1 Voting Implementation Issues ......................................................................................................... 60 11.2.2 Risk-Based Engagement Implementation Issues............................................................................. 61 12. Other Issues ......................................................................................................................................... 62 13. Summary .............................................................................................................................................. 63 14. Recommendations................................................................................................................................ 67 15. Acknowledgements .............................................................................................................................. 68 Appendix 1 Abbreviations / Definitions ...................................................................................................... 69 Appendix 2 ....................................................................................................................................................... 76 A2-1. Submissions Received by the Finance & Investment Advisory Board ......................... 76 A2-2. Other Contributions................................................................................................................... 76 A2-3. Research and other References .............................................................................................. 77 Attachment A ................................................................................................................................................... 79 Attachment B ................................................................................................................................................... 91



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1. Executive Summary The Chief Minister has requested that the Chief Minister’s Department, with the assistance of the independent, non-executive members of the Finance & Investment Advisory Board (the Board), undertake a review of the extent to which environmental, social and governance (ESG) principles could be incorporated into the investment decision-making processes for the Territory’s investment portfolios. In this report the Board has limited its consideration of ‘Territory investments’ to the investment funds of the Superannuation Provision Account (SPA) and the Territory Banking Account (TBA) managed by the Department of Treasury (Treasury). Other decisions of the ACT Government that relate to, for example, funding for the capital works program, education, health, housing and specific social issues are outside the scope of this review. These are matters to be decided by the Government in the context of its budget policy setting process and appropriation framework and do not relate to institutional investment portfolio management. This review draws largely upon published research, much of it recognising the fiduciary responsibilities of institutional investors, and the views of peak bodies and organisations that are involved in, or have some interest in, financial investment management or operations. The incorporation of ESG issues into the funds management framework has evolved over time from one of applying ‘values’ to one of addressing investment risk. This changed emphasis reflects:

The fiduciary responsibilities of institutional investors to maximise investment returns within acceptable risk tolerances, acknowledging that many ESG issues will ultimately impact on valuations and hence investment returns; and

The inherent difficulties in deciding upon the suite of values to be applied. It was not until the latter part of the 20th century that socially responsible investing gained momentum in Australia, with investment objectives framed to incorporate social good based on a set of ‘values’. Until recently these socially responsible investing (SRI) or ‘ethical’ funds were primarily restricted to the retail market, with limited offerings becoming available within the institutional investment market over the past few years. In 2005 the landmark Freshfields Report, commissioned by the United Nations Environment Programme Finance Initiative Asset Management Working Group, examined whether the consideration of ESG issues as part of the investment decision-making process was legally permissible in a range of countries, including Australia. The Freshfields Report concluded that “integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions.”

The publication of the Freshfields Report was closely followed by the joint release in April 2006 of the UN Principles for Responsible Investment (UN PRI) by the United Nations Environment Programme Finance Initiative and the United Nations Global Compact. The UN PRI is based on the premise that ESG issues can affect investment performance and that the appropriate consideration of these issues is part of delivering superior risk adjusted returns and is therefore firmly within the bounds of investors’ fiduciary duties.



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The UN PRI is designed to be compatible with the investment styles of large diversified institutional investors that operate within the traditional fiduciary framework and suggests a risk-based policy of engagement with companies rather than a values-based screening approach. Consistent with the UN PRI, direct engagement with companies and proxy voting are the two key processes that are being adopted by institutional investors in implementing a risk-based approach to ESG issues. The engagement process provides for proactive engagement with the management and boards of companies on ESG issues and seeks to directly influence and change corporate behaviour. Within Australia the engagement process is generally implemented through specialist third party service providers and does not override the mandated responsibilities of the fund manager(s) appointed by an institutional investor. For institutional investors voting can be exercised directly by the investor or through delegated authority to a third party (proxy voting). Where an investor places funds into a pooled fund operated by a fund manager, the fund manager has sole responsibility for exercising votes on behalf of the unit holders. To date the voting approach to ESG issues has been limited primarily to governance issues. This review has noted that governments in Australia overall have taken an arm’s-length approach to the management of investments with little, if any, explicit recognition of ESG issues. Many superannuation schemes offer SRI options to members under choice of fund arrangements. Some superannuation funds consider ESG issues more broadly as part of the general investment decision-making process. This review has also found that to varying degrees a risk-based approach to ESG issues is also being implemented into investment management processes by the current SPA and TBA fund managers. The Territory’s two main pools of investment funds, the SPA and the TBA, are governed by the Financial Management Act 1996 which requires the prudent management of fiscal risks arising from the management of the Territory’s assets and liabilities. The Act also requires that the investment of TBA moneys may only be made to increase or protect the financial wealth of the Territory. This review has assessed the relative merits and implementation of both a values-based and risk-based approach to ESG issues in the management of the Territory’s investments. The Board has come to the view that a risk-based approach is preferred. Paramount to this view is the Board’s belief that the use of values-based screening for the Territory’s investments is not consistent with the overriding obligations of the prudent fiscal management of risks. Other key factors that have been taken into consideration include:

Screening does not necessarily influence or change corporate behaviour; The establishment of ‘values’ criteria by the ACT Government is especially problematic in

that many of the activities that may be considered socially undesirable are legally permitted activities and in some cases are engaged in by responsible governments;



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Screening reduces the size of the investable universe, potentially resulting in a higher volatility in returns relative to the benchmark return and, particularly in the case of negative screening, a less diversified portfolio;

A risk-based approach is holistic and broader in its reach than screening, recognising that institutional investors are universal long-term holders of broadly diversified portfolios consistent with the prudent management and diversification of risk; and

The implementation of a risk-based approach through the engagement process is directly targeted at changing corporate behaviour as a means to achieving improved ESG outcomes.

There is no conclusive evidence on the expected impact on gross returns and risks resulting from a values-based approach to ESG investment. In the current market the management fees payable for values-based ESG products are some 0.3% to 0.5% higher than management fees payable for traditional investment portfolios. In the absence of conclusive evidence and taking into account the differential in management fees, the Board has some concerns that if it were to adopt a values-based approach to ESG investment, the ACT Government would be open to criticism from taxpayers that it was not meeting its fiduciary responsibilities. The key impacts of a values-based approach to the SPA investment portfolio have been estimated as follows:

An initial cost of $2.8 million to $8.5 million in transitioning to a values-based approach. If ESG values changed for any reason, further transitioning costs may be incurred;

An increase in ongoing management fees of $5.7 million to $9.9 million per annum; and An increased risk that the current funding plan objectives for the SPA portfolio may not be

met. A risk-based approach to ESG issues would not require a change to the existing structure of the SPA portfolio. Therefore, the key impacts of such an approach would be the additional estimated costs of an engagement service provider of up to $500,000 per annum and $25,000 per annum for a third party proxy voting service provider. However, if it was determined that the ACT Government wished to exercise its voting decisions directly, the existing SPA equity investments under pooled fund arrangements would need to be liquidated at an estimated cost of $1.2 million to $ 3.7 million and placed with a fund manager(s) under separately established mandates. This would result in an estimated increase in ongoing management fees of some $2.0 million to $3.3 million per annum. Under either a values-based or a risk-based approach to ESG issues it is the Board’s view that an additional Treasury resource would be required to properly oversight and monitor these arrangements.



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In considering the following recommendations, the Board requests the ACT Government to note in particular the following:

The Freshfields Report found a risk-based approach to ESG issues is consistent with the fiduciary duties of institutional investors;

A risk-based approach is current best practice for institutional investors; and The approach to ESG issues in institutional investing is evolving and implementation

remains a challenge. Therefore it is important that the ACT Government takes a considered and measured approach to the application of ESG issues to the Territory’s investment practices.

Recommendations The Board recommends that: 1. The ACT Government adopts a risk-based approach to the application of ESG issues to

the Territory’s investment practices.

2. The ACT Government adopts the principles for responsible investing, as set out in the UN PRI.

3. ACT Treasury monitors the extent to which the Territory’s fund managers and asset consultants are taking into account ESG issues in investment decision-making processes.

4. The ACT Government considers the appointment of a third party engagement service provider to assist in the implementation of a risk-based approach to ESG issues for the Territory’s investments.

5. ACT Treasury requires the Territory’s fund managers to provide their voting policies, requests that they exercise their voting rights and report on their voting activities.

6. The ACT Government considers the engagement of a third party proxy voting service provider.



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2. Terms of Reference The Chief Minister has requested that the Chief Minister’s Department (CMD), with the assistance of the externally appointed Members of the Investment Advisory Board (the Board), undertake a review of the extent to which the Territory investment operations should incorporate environmental, social and governance (ESG) principles. The Terms of Reference are as follows:

The review will:

1. Consider the various approaches to ‘ethical investment’ including socially responsible investment, sustainable investment and corporate governance responsibility.

2. Report on the manner in which ESG principles are being incorporated into the

investment processes of other government jurisdictions, superannuation schemes and institutional investors in Australia.

3. Report on the nature of and performance of ESG/ethical investment products

(both domestic and international) available to institutional investors.

4. Advise on the potential implications of incorporating ESG principles into the Territory’s investment processes, including:

the financial impacts, including impact on risk profile, investment returns, costs of funds under management and the implications, if any, for the Territory’s superannuation funding plan;

transition process and costs; and ongoing operations.

5. Identify the extent to which ESG principles could be implemented across the

range of the Territory’s investment portfolios, including consideration of any market capacity constraints, changes required to current investment mandates and any changes required to existing legislation and guidelines.

2.1 Process This review draws largely upon published information and research, much of it recognising the fiduciary responsibilities of institutional investors. In addition, the views of peak bodies and organisations that are involved in, or have some interest in, financial investment management or operations, as well as the views of the members of the ACT Legislative Assembly and other State and Territory governments were invited. The respondents are listed in Appendix 2. The submissions received contributed to the findings of this review. The Board expresses its appreciation to all respondents for their contributions.



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ACT Treasury officers provided secretariat assistance to the review including the provision of data and research. The services of the ACT Department of Treasury’s (ACT Treasury) asset consultant, Frontier Investment Consulting (Frontier), were also utilised.

2.2 Exclusions In this report the Board has limited its consideration of ‘Territory investments’ to the investment funds of the Superannuation Provision Account (SPA) and the Territory Banking Account (TBA) managed by the ACT Treasury. There are two significantly smaller Territory investment portfolios that have not been considered as part of this review. These are:

Trust funds invested by the Public Trustee for the ACT, with the investment processes undertaken in accordance with prudent person trust investment principles prescribed under the Trustee Act 1925.

The manner in which investments under the control of the Public Trustee are to be managed is set out in the Public Trustee Act 1985 and the Trustee Act 1925. Appropriately, the ACT Government is not able to direct how these investments should be managed.

Investments of levies collected to administer long service leave entitlements of employees and contractors working in the ACT building and construction industry and the ACT cleaning industry. The ACT Long Service Leave Board manages these levies and at the end of May 2007 they totalled some $70 million.

These investment arrangements, given their size, were not specifically examined as it was considered that any recommendations made in this report might flow through to these investments in any case.

Other decisions of the ACT Government that relate to, for example, funding for the capital works program, education, health, housing and specific social issues are outside the terms of this review. These are matters to be decided by the ACT Government in the context of its budget policy setting process and appropriation framework and do not relate to institutional investment portfolio management.



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3. ACT Government (Territory) Investments The two major investment portfolios administered within ACT Treasury are the SPA and TBA and collectively involve invested funds totalling some $3.0 billion at the end of May 2007. The review has focussed its attention on the operation of these two portfolios. The investment provisions for these portfolios are set out in the Financial Management Act 1996 (FMA) and the Territory Superannuation Provision Protection Act 2000 (TSPPA). The investment decision-making framework for Territory investments is further explained, as well as the broad framework for other institutional investment funds, such as superannuation funds, in Section 6 of this report.

3.1 Superannuation Provision Account (SPA) The SPA was established in 1991 as a vehicle by which the ACT Government sets funds aside to meet future unfunded employer superannuation obligations for its employees who are members of the CSS and PSS defined benefit schemes. The SPA does not hold any employee (member) superannuation contributions or employer productivity contributions. The ACT Government pays employee superannuation contributions and employer productivity contributions directly to Comsuper as they accrue. In May 2000, when considering the Territory Superannuation Provision Protection Bill 2000, the purpose for the establishment of the SPA, including the investment arrangements as set out in the Bill, was supported by all members of the ACT Legislative Assembly. The TSPPA provides that moneys held in the SPA cannot be used for any purpose other than for meeting the Territory’s employer superannuation liabilities. The ACT Government has adopted a funding plan under which the ACT Government is committed to fully fund its projected employer superannuation liability by 2030. The funds held in the SPA are invested in a manner similar to a large institutional investor or a superannuation fund. Funds are invested to achieve a long-term investment return of 5% real (net of CPI and fees) across a range of investment classes. Investment assets held by the SPA include Australian and international money market securities, Australian and international equities, Australian and international fixed interest securities, Australian private equity and Australian direct unlisted property. These investments are projected to grow over time through periodic injection of funds by the Government and the reinvestment of all earned income. The SPA’s financial assets are invested and managed according to an asset allocation strategy that takes into account the risk/return objectives of the Territory and the long-term nature of the superannuation liabilities and projected cash flow requirements. External asset-specific institutional fund managers are appointed to manage these investments, under investment agreements that reflect the legislative requirements of the FMA and the TSPPA. Fund managers are appointed for periods of five years or more to meet targeted investment needs as



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part of the overall strategic investment objectives of the Territory. Fund manager mandates require them to be invested in their selected investment style, thereby contributing to the overall risk diversification objectives of the portfolio. ACT Treasury uses the services of an appointed Asset Consultant and a Master Custodian, similar to services utilised by superannuation funds and large institutional investors, as part of the investment management arrangements for the SPA. Invested funds were some $2.1 billion at the end of May 2007.

3.2 Territory Banking Account (TBA) The TBA investments comprise the cash balance from the TBA and cash held by ACT Government agencies in their banking accounts. Territory authorities have the option of transferring funds to the ACT Treasury centrally managed pooled investment arrangement. These balances are funds that are invested in money market securities until called upon by the ACT Government agencies and authorities in accordance with the budget policy and appropriation allocations. The investment horizon is predominantly short-term given that portfolio liquidity is essential to facilitate the daily cash requirements of the Territory’s agencies and authorities. The TBA financial assets are invested and managed according to an asset allocation strategy that takes into account the risk/return objectives of the Territory and projected cash flow requirements. External asset-specific institutional fund managers are appointed to manage these investments, under investment agreements that reflect the legislative requirements of the FMA. ACT Treasury uses the services of an appointed Asset Consultant and a Master Custodian as part of the investment management arrangements for the TBA. Invested funds were some $0.9 billion at the end of May 2007.



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4. A Brief History of Ethical Investment, SRI and ESG In the 1650s, the Quakers were credited as the first group of investors to apply social criteria on investing standards. These criteria arose through their belief in human equality and non-violence.1 In the 1920s the Methodist Church wished to start trading on the stock market, but wanted to avoid investing in companies involved in the manufacture of tobacco and alcohol. The Quakers followed suit, and added weapons manufacture to their list of banned investments. In 1928, a fund was introduced that applied screens to meet the needs of other church group investors who also did not wish to invest in ‘sin’ stocks.2 In 1971, a group of Methodists founded the Pax World Fund, which was the first mutual fund to adopt a socially responsible method of investing, arising from demand for investment in companies that did not profit from the Vietnam War.3 Since the latter part of the 20th century, Socially Responsible Investing (SRI) momentum can be directly traced to particular events that have galvanised heightened sensitivities to issues of social responsibility and accountability. Examples of this were the Vietnam War, civil rights issues in the US, the apartheid regime in South Africa, large and well-publicised environmental disasters (Bhopal, Chernobyl and Exxon Valdez) and increasing information on emerging environmental issues such as ozone depletion and climate change. More recently, high profile corporate scandals such as Enron and subsequent US legislation in particular (for example Sarbanes Oxley) have resulted in a focus on corporate governance. Within Australia, the first significant public SRI equity products began in the mid 1980s but it was not until the early 2000s that interest in SRI equity products, and the number of product offerings, escalated, albeit still on a relatively small scale. The initial SRI investment products were mainly focused on the equity asset classes. They were typically based on meeting the needs of a small group of niche investors and generally adopted values-based SRI screening criteria. These products were usually referred to as socially responsible or SRI products. In the early 2000s, a number of superannuation funds introduced member investment choice options using these products. Anecdotal evidence suggests that while the take up of the SRI options in Australia is growing significantly, it is doing so from a very small base.

4.1 Recent Developments For many years, the term SRI has been used to describe an investment process within which investment objectives are framed to incorporate achieving social good, as well as attempting to maximise financial returns. Terms such as ‘corporate social investment’ or ‘corporate responsibility’ have also been used to describe similar investment objectives, typically constructed around a set of values held by a particular investor. The values-based approach to SRI has since evolved to ESG and to a broader risk-based approach that is more mainstream. 1 Frontier Investment Consulting, Socially Responsible Investing: Issues for Superannuation Funds, May 2002, p. 5. 2 Frontier Investment Consulting, op. cit., p. 5. 3 ibid., p. 5.



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The dilemma faced by investors in setting ‘values’ has been summarised by Laurence B Siegel as follows:

“Many investors are concerned about the moral implications of their portfolio decisions as well as the investment returns resulting from these decisions. These moral implications include social, environmental, and religious matters. Some investors try to satisfy these concerns simply by avoiding undesirable investments. But no two investors agree precisely on what investments or social outcomes are undesirable or on how much diversification and opportunity the investor or investment manager should sacrifice in seeking to keep their portfolio ‘clean’. In addition, some investors seek to use the investment process to further their social or other goals through proactive investment in companies or projects believed to do good, not just shunning those believed to create harm.”4

The changed emphasis over time from one of applying ‘values’ to one of addressing investment risk reflects:

The fiduciary responsibilities of institutional investors to maximise investment returns within acceptable risk tolerances, acknowledging that many ESG issues will ultimately impact on valuations and hence investment returns; and

The inherent difficulties in deciding upon the suite of values to be applied. The Australian Council of Super Investors (ACSI) defines ESG as follows:

“ESG refers to the system by which investors protect and manage their investments for the long-term through consideration of environmental, social and governance (ESG) risks in their investment decision-making processes.”5

Institutional investors now tend to regard ESG issues in the context of managing risk and active share ownership. This approach has taken a number of forms but is generally moving towards a total portfolio approach. Proxy voting has become increasingly widespread among institutional investors. A smaller number of investors are engaging corporations directly themselves or through third party engagement programs with the aim to improve the behaviour of companies. The issues discussed through the engagement process are broad ranging and may include workplace health and safety, business ethics, board remuneration, alignment of interest and independence, and environmental issues. In terms of evolving practice for institutional investors, three of the key developments over the past several years have been the UN Global Compact, the “Freshfields Report” and the UN Principles of Responsible Investment (UN PRI).

4 Laurence B Siegel, Research Director, The Research Foundation of CFA Institute in the Forward to the publication The Social Responsibility of the Investment Profession, July 2006, http://www.cfapubs.org/doi/pdf/10.2470/rf.v2006.n3.4251 5 An “ESG” Glossary, published by ACSI



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4.2 United Nations Global Compact In an address to the World Economic Forum on 31 January 1999, the former Secretary-General of the United Nations, Kofi Annan, challenged business leaders to join an international initiative – the Global Compact – that would bring companies together with UN agencies, labour and civil society to support universal environmental and social principles. The Global Compact’s operational phase was launched at the UN Headquarters in New York on 26 July 2000. Today, thousands of companies from all regions of the world, international labour and civil society organisations are engaged in the Global Compact, working to advance ten universal principles in the areas of human rights, labour, the environment and anti-corruption.6 Through the power of collective action, the Global Compact seeks to promote responsible corporate citizenship so that business can be part of the solution to the challenges of globalisation. In this way, the private sector – in partnership with other social actors (governments, companies, labour, civil society organisations, and the United Nations) – can help realise the Secretary-General’s vision: a more sustainable and inclusive global economy.7 The Global Compact is a purely voluntary initiative with two objectives:

Mainstream the ten principles in business activities around the world; and Catalyse actions in support of UN goals.

The Global Compact asks companies to embrace, support and enact, within their sphere of influence, a set of core values in the areas of human rights, labour standards, the environment, and anti-corruption:

Human Rights Principle 1: Businesses should support and respect the protection of

internationally proclaimed human rights; and

Principle 2: make sure that they are not complicit in human rights abuses.

Labour Standards Principle 3: Businesses should uphold the freedom of association and the

effective recognition of the right to collective bargaining;

Principle 4: the elimination of all forms of forced and compulsory labour;

Principle 5: the effective abolition of child labour; and

Principle 6: the elimination of discrimination in respect of employment and occupation.

Environment Principle 7: Businesses should support a precautionary approach to

environmental challenges;

Principle 8: undertake initiatives to promote greater environmental responsibility; and

6 http://www.unglobalcompact.org/ 7 ibid.

http://www.unglobalcompact.org/AboutTheGC/TheTenPrinciples/index.htmlhttp://www.unglobalcompact.org/AboutTheGC/TheTenPrinciples/humanRights.htmlhttp://www.unglobalcompact.org/AboutTheGC/TheTenPrinciples/humanRights.htmlhttp://www.unglobalcompact.org/AboutTheGC/TheTenPrinciples/labourStandards.htmlhttp://www.unglobalcompact.org/AboutTheGC/TheTenPrinciples/environment.htmlhttp://www.unglobalcompact.org/AboutTheGC/TheTenPrinciples/humanRights.htmlhttp://www.unglobalcompact.org/AboutTheGC/TheTenPrinciples/labourStandards.htmlhttp://www.unglobalcompact.org/AboutTheGC/TheTenPrinciples/environment.html



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Principle 9: encourage the development and diffusion of environmentally friendly technologies.

Anti-Corruption Principle 10: Businesses should work against corruption in all its forms,

including extortion and bribery.8 In support of the UN Global Compact (2000), the Global Reporting Initiative (GRI) has adopted the following concepts of environmental, social and economic impacts:

“The environmental dimension of sustainability concerns an organization’s impacts on living and non-living natural systems, including ecosystems, land, air and water.”

“The social dimension of sustainability concerns the impacts an organization has on the social systems within which it operates.”

“The economic dimension of sustainability concerns the organization’s impacts on the economic conditions of its stakeholders and on economic systems at local, national, and global levels.”9

4.3 The “Freshfields Report” In 2005, the Asset Management Working Group of the United Nations Environment Programme Finance Initiative (UNEP-FI), which consisted of 13 fund managers with a combined mandate of US$1.7 trillion, commissioned the law firm Freshfields Bruckhaus Deringer to answer the following question:

“Is the integration of environmental, social and governance issues into investment policy (including asset allocation, portfolio construction and stock-picking or bond-picking) voluntarily permitted, legally required or hampered by law and regulation; primarily as regards public and private pension funds, secondarily as regards insurance companies reserves and mutual funds?”10

Freshfields Bruckhaus Deringer, in its report to the UNEP-FI, ‘A legal framework for the integration of environmental, social and governance issues into institutional investment’ (October 2005), (the Freshfields Report), concluded that:

“Conventional investment analysis focuses on value, in the sense of financial performance. …, the links between ESG factors and financial performance are increasingly being recognised. On that basis, integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions.

8 http://www.unglobalcompact.org/AboutTheGC/TheTenPrinciples/index.html 9 http://www.globalreporting.org/NR/rdonlyres/A1FB5501-B0DE-4B69-A900-27DD8A4C2839/0/G3_GuidelinesENG.pdf 10 Freshfields Bruckhaus Deringer, A legal framework for the integration of environmental, social and governance issues into institutional investment’, October 2005, http://www.unepfi.org/fileadmin/documents/freshfields_legal_resp_20051123.pdf, p.6

http:/opencms/AboutTheGC/TheTenPrinciples/anti-coruption.html



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It is also arguable that ESG considerations must be integrated into an investment decision where a consensus (express or in certain circumstances implied) amongst the beneficiaries mandates a particular investment strategy and may be integrated into an investment decision where a decision-maker is required to decide between a number of value-neutral alternatives. …In all jurisdictions, investment decisions will not be assessed with the benefit of hindsight, but against reasonable standards of decision-making taking into account the information available to the decision-maker at the time of the decision. Provided that all relevant considerations have been taken into account, the weight that the decision-maker gives to each consideration or category of consideration is left to the discretion of the investment manager alone.”11

The Centre for Australian Ethical Research (CAER) and Australian Ethical Investments Limited (AEI) supported the findings of the Freshfields Report in their submissions to this review. CAER noted the following:

“The issue of performance has occupied the ethical investment industry for many years. Accepted wisdom amongst traditionalists in the finance sector was that it was possible to manage a fund according to ethical criteria, but only at the expense of returns. This argument is now officially dead. …The key finding of this [Freshfields] report was that rather than compromising fiduciary duty by adopting an ethical investment policy, trustees may in fact be acting in breach of their fiduciary duty if they disregard ESG principles….”12

AEI, in its submission to this review, also referred to the conclusions of the Freshfields Report and noted that:

“The report prepared in October 2005 by the international law firm, Freshfields Bruckhaus Deringer titled ‘A Legal Framework for the integration of environmental, social and governance issues into institutional investment’ is a comprehensive resource on the implications of legal rules for investment decision makers’ ability to integrate ESG considerations into their decision-making, in Australia, Canada, the US, Europe and Japan. Freshfields argues several points: that there is a body of credible evidence that ESG criteria have a role to play in

considering the ‘proper analysis of investment value’(p11);

to ignore them may result in an investment being given an inappropriate value, (for example, to ignore climate change); and

a failure to identify such issues and assess their weight may constitute a failure to consider the best interests of beneficiaries.”13

11 ibid., p. 13. 12 CAER submission to the ACT Government’s Review of the Application of Environmental, Social And Governance Issues to Territory Investment Practices, p. 9. 13 AEI submission to the ACT Government’s Review of the Application of Environmental, Social And Governance Issues to Territory Investment Practices.



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The policy position of the Association of Superannuation Funds of Australia Limited (ASFA) with respect to the consideration of ESG issues is consistent with the key finding of the Freshfields Report. The ASFA Policy Principles, November 2005, at paragraph 24.30, state:

“It is the trustee’s fiduciary duty to consider actual and potential investments from a financial performance viewpoint, noting that a range of factors such as social and environmental considerations can affect financial performance.”14

Further, Australian Reward Investment Alliance (ARIA), in its submission to this review, noted that:

“Prominent corporate failures in recent years have resulted from inadequate attention to Environmental, Social and Governance (ESG) risks, causing significant losses for shareholders, and damaging confidence in investment markets.”15

The integration of ESG factors into the decision-making processes of mainstream institutional investors is slowly evolving. Influencing factors have included institutional investors concerns about the legality of taking into consideration ESG factors and the different investment horizons of participants in the institutional investment market. The investment time horizon of an institutional investor will influence the investment strategies and analyses to be adopted. Long-term risks, such as risks that may be associated with climate change, will be more relevant for long-term investors in meeting their performance objectives. The Freshfields Report found that:

“Despite the growing body of evidence that ESG issues can have a material impact on the financial performance of securities and an increased recognition of the importance of assessing ESG-related risks, those seeking a greater regard for ESG issues in investment decision-making often encounter resistance on the basis of a belief that institutional principals and their agents are legally prevented from taking account of such issues.

The law also acknowledges the predominance of the modern portfolio theory in investment management, in which portfolios of investments are selected on their overall risk-reward characteristics rather than individual securities being selected on the basis of their individual risks and returns. Selecting an appropriately diversified portfolio is a crucial part of effective portfolio management. This is manifested in the balance that is sought to be struck between the different types of assets, such as equities, bonds and cash, and different geographic spreads, industries or sectors.

Investment decision-making is also concerned with varying time horizons depending upon the investment involved. Pension fund investments in particular are intended to yield returns at some considerable distance in the future. It is therefore necessary when assessing investment decision-making against legal standards to have regard to the expected long-term performance of investments

14 http://www.superannuation.asn.au/ArticleDocuments/116/ASFA-Policy-Principles.pdf 15 ARIA submission to the ACT Government’s Review of the Application of Environmental, Social And Governance Issues to Territory Investment Practices, p. 3.



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where the fund involved demands a return on investment over an extended horizon.

Conforming with the correct process requires decision-makers to have regard to all considerations relevant to the decision, including those that impact on value. In our view, decision-makers are required to have regard (at some level) to ESG considerations in every decision they make. This is because there is a body of credible evidence demonstrating that such considerations often have a role to play in the proper analysis of investment value. As such they cannot be ignored, because doing so may result in investments being given an inappropriate value.”16

The Freshfields Report noted that Australian fund managers have historically taken a view that ESG investment adversely impacts on their fiduciary obligations, most importantly on their responsibility to maximise returns for beneficiaries. The Freshfields Report attributed this to long held views that ESG investments generate comparatively less favourable financial returns when compared with more traditional investments, and that increased investment volatility is experienced due to restricted diversification and increased portfolio risk weighting.17 Nonetheless, the Freshfields report contends that recent arguments and commentary suggest that:

“Fiduciary duties can co-exist with environmental, social or ethical considerations, provided that trustees place the financial interests of their beneficiaries ahead of these considerations.”18

The report ‘Responsible Investment in Focus: How leading public pension funds are meeting the challenge’ (April 2007), jointly prepared by the UNEP-FI Asset Management Working Group and the United Kingdom Social Investment Forum Sustainable Pensions Project, observed that:

“A wide range of issues that five years ago were considered “non-financial” such as climate change, human rights and board remuneration are now coming to the fore as factors that can have a significant impact on investment value.

The role of environmental, social and governance (ESG) issues in company valuations is increasingly being documented by analysts from leading firms such as Goldman Sachs, UBS and Morgan Stanley. Internationally renowned experts such as former World Bank chief economist Sir Nicholas Stern are adding their voices. For example, his report for the UK government in 2006 warned that global warming linked to climate change could shrink the global economy by 20%.

Institutional investors are becoming aware of the need to take into account ESG issues, particularly pension funds and others with a remit to take a long-term perspective. The question is - how?

Many investors are grappling with these issues, and there can be both hesitation and confusion as to how to reconcile the integration of ESG issues with the thorny question of fiduciary responsibility.

Research in this area has helped provide some answers. For example, the recent study by international law firm Freshfields suggested that, far from consideration of ESG issues

16 Freshfields Bruckhaus Deringer, op. cit., p.6, 7, 10. 17 ibid., p. 44-45. 18 ibid., p. 48.



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being contrary to fiduciary duty, failure to assess these may well breach a trustee’s duty to act in the best interests of scheme beneficiaries.

Ironically, as one of the primary providers of the capital fuelling the international markets, pension funds are in a unique position to influence market participants, principally their fund managers, to value ESG factors appropriately and integrate them into the investment process.”19

The Freshfields Report noted that in a 2005 Mercer Investment Consulting survey of 195 funds managers from around the world, 70% of fund managers believed the integration of ESG factors into investment analysis would become a mainstream part of investment management within 3 to 10 years.20 Moreover, the Freshfields Report noted:

“Commentary suggests that this movement toward mainstream consideration of ESG issues in investment decision-making is a response to a variety of different factors, including the following:

Increasing evidence of a nexus between performance on ESG issues and

financial performance;

Stakeholder activism; Reputational concerns: Consumer pressure/public opinion; Pressure from research bodies, investor initiatives and non-government

organisations (NGO’s);

Pressure from the insurance industry; Introduction of corporate environmental reporting obligations; The rise of the global company; Adoption of investment guidelines by the World Bank, IFC and other

intergovernmental lenders;

Growing corporate transparency; The information technology revolution; and Regulation mandating disclosure of ESG investment policies.”21

19 http://www.unepfi.org/fileadmin/documents/infocus.pdf, p.8 20 Freshfields Bruckhaus Deringer, op. cit., p. 23. 21 ibid., p. 24.



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4.4 United Nations Principles for Responsible Investment In April 2006 the UNEP-FI and the UN Global Compact jointly released the UN PRI. The UN PRI are an aspirational set of principles seeking to integrate social, environmental and governance issues into investment decision-making. The UN PRI was developed by a group of investment professionals representing 20 large institutional investors from 12 countries whose investment horizon is generally long, and whose portfolios are often highly diversified. The UN PRI is based on the premise that ESG issues can affect investment performance and that the appropriate consideration of these issues is part of delivering superior risk-adjusted returns and is therefore firmly within the bounds of investors’ fiduciary duties. The UN PRI clearly states that the principles are to be applied only in ways that are consistent with those duties. The UN PRI provides investors with a high-level framework for integrating ESG issues into investment decisions. As signatories develop policies and procedures for implementation, the UN PRI secretariat will be on hand to help investors implement them. The six UN PRI principles are expressed as follows:

1. “We will incorporate ESG issues into investment analysis and decision-making processes.

2. We will be active owners and incorporate ESG issues into our ownership policies and practices.

3. We will seek appropriate disclosure on ESG issues by the entities in which we invest.

4. We will promote acceptance and implementation of the Principles within the investment industry.

5. We will work together to enhance our effectiveness in implementing the Principles.

6. We will each report on our activities and progress towards implementing the Principles.” 22

The UN PRI states, inter alia, that:

“The Principles are designed to be compatible with the investment styles of large, diversified institutional investors that operate within the traditional fiduciary framework. The Principles apply across the whole investment business and are not designed to be relevant only to SRI products.”

“Do the Principles call for exclusion or screening out of particular companies or sectors? No. The Principles suggest a policy of engagement with companies rather than screening or avoiding stocks based on ESG criteria (although this may be an appropriate approach for some investors). The Principles are generally designed for large investors that are highly diversified and have large stakes in companies, often making divestment or avoidance impractical.”

22 http://www.unpri.org/principles/



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“The Principles have been designed as a commitment from the top-level leadership of the whole investment business.”23

The benefits of signing the UN PRI, as articulated in September 2006 by Steve Waygood, Chair of the UK Social Investment Forum, are:

“Adopting a common framework for collaborative engagement; Receiving implementation support from a PRI secretariat; Providing access to examples of good practice from a global network of peers

(including many of the world’s largest institutional investors);

Providing opportunities to collaborate with other signatories to reduce research and implementation costs; and

Providing reputational benefits from demonstrating top-level commitment to integrating ESG issues.”24

By April 2007 in excess of 180 leading institutions had become signatories to the UN PRI since it was launched on 27 April 2006, with these institutions having in excess of US$8 trillion funds under management. Australian signatories include:

ARIA (Australian Reward Investment Alliance) Australian Super CARE Super Catholic Superannuation Fund CBUS Superannuation Scheme Christian Super Hesta Super Local Super Statewide Superannuation Trust UniSuper VicSuper Vision Super AMP Capital Investors Australian Ethical Investments Ltd BT Financial Group Colonial First State Global Asset Management Drapac Five Oceans Asset Management

23 http://www.unpri.org/faqs/ 24 Steve Waygood, Chair, UK Social Investment Forum, The Power of Engagement: The UN PRI in Practice, 22 September 2006.



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Foresters ANA Mutual Society Ltd Indian Ocean Rim Asset Management Pty Ltd Portfolio Partners Limited Australian Council of Super Investors (ACSI) Frontier Investment Consulting Monash Sustainability Enterprises RepuTex Group Sustainable Investment Research Institute Pty Ltd (SIRIS).25

It is not clear whether the Australian Capital Territory (the body politic) is eligible to become a signatory to the UN PRI. Attachment A is a copy of the UN PRI, and Attachment B identifies the list of all signatories to the UN PRI at the end of May 2007.

25 http://www.unpri.org/signatories/



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5. What’s Happening in Australia Today? The Freshfields Report observed that Australia has been a comparatively slow adopter of ESG. Some of the key factors behind this have been reported as being:

“definitional issues and confusion over what constitutes ESG; the perception that ESG funds underperform when compared with the broader

market – although anecdotal evidence on the performance of a number of Australian ESG funds suggests this is not the case, there is a lack of empirical research supporting this conclusion;

confusion over whether ESG is consistent with fund managers’ fiduciary responsibilities to their fund members or investors – which is associated with the perception that ESG is a poor performer when compared to the broader market because it results in a restriction of the ‘investable universe’;

a lack of superannuation fund choice for employees – until recently, employees have not been able to direct their employers on where to invest compulsory employer superannuation contributions but new legislation allows employees to choose where these funds are invested, enabling employees to choose superannuation funds adopting ESG strategies; and

a lack of investor demand.” 26

5.1 Commonwealth Government’s Parliamentary Joint Committee on Corporations and Financial Services

The Commonwealth Government’s Parliamentary Joint Committee on Corporations and Financial Services (the Joint Committee) reported on Corporate responsibility: Managing risk and creating value in June 2006. Its report noted that institutional investors have the capacity to advance corporate responsibility, including the management of non-financial risks, due to the control of large shareholdings that they hold in listed companies. 27 The report notes that long-term investors are most exposed to social and environmental risks embedded in the companies in which they invest. Given the longer investment timeframes, institutional investors are viewed as being able to support strategies that may not yield immediate profits but provide the potential for longer-term sustainable profitability. The ‘sole purpose test’ for superannuation investors operating under the Superannuation Industry (Supervision) Act 1993 [Cwlth] (SIS Act) was raised before the Joint Committee, and it was suggested that this restricted superannuation trustees in investment opportunities. The Joint Committee was not persuaded by this view, and reported “consideration of social and environmental responsibility is in fact so far bound up in long term financial success that a superannuation trustee would be closer to breaching the sole purpose test by ignoring corporate responsibility”. The Joint Committee recommended that the Australian Prudential Regulation

26 Freshfields Bruckhaus Deringer, op.cit., p.44. 27 http://www.aph.gov.au/senate/committee/corporations_ctte/corporate_responsibility/report/report.pdf



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Authority (APRA) issue detailed guidelines on the sole purpose test to clarify this issue. As at the date of this report, no such guidelines have been issued.28 The Joint Committee also recommended that institutional investors seriously consider becoming signatories to the UN PRI, and recommended that the Australian Government’s Future Fund become a signatory. In a further recommendation the Joint Committee proposed that the Australian Stock Exchange Corporate Governance Council should review its “Principles of Good Corporate Governance Practice and Best Practice Recommendations to the effect that companies should inform investors of the material non-financial aspects of a company’s risk profile by disclosing their top five sustainability risks (unless they demonstrate having fewer); and providing information on their strategies to manage such risks.”29 Senator Grant Chapman, Chairman of the Joint Committee, provided a written submission to this review. While noting that the Joint Committee’s report’s main focus is on corporate Australia, Senator Chapman highlighted that “it is also highly relevant to public sector institutional investors.”30

5.2 Australian Stock Exchange The ASX Corporate Governance Council (ASX Council) circulated a consultation paper to companies in November 2006.31 This paper proposed that governance practices directed to the recognition and management of risk apply to both financial (the risk of a material error in the financial statements) and non-financial risks (other risks such as operational, environmental, sustainability, compliance, strategic or external, ethical conduct, reputation or brand, technological, product or service quality and human capital which if not properly managed will impact on the company). More than 100 submissions were received, and the ASX Council has stated that it expects to be able to release the finalised Principles by the end of June 2007.32 As expressed through the submissions, views varied significantly. Not unexpectedly, concerns have been raised with additional cost burdens on companies, disclosure of risks for Australian companies giving rise to advantages for international companies not required to do likewise and the potential exposure for company directors should circumstances prove wrong. Nonetheless, there is broad acceptance that ‘non-financial’ risks can impact adversely on company valuations, and as such are a critical factor for institutional investors. Proper understanding and assessment of likely investment risks and returns is an inclusive requirement of fiduciary duty and care.

28 http://www.apra.gov.au/home.cfm 29 http://www.aph.gov.au/senate/committee/corporations_ctte/corporate_responsibility/report/b03.htm 30 Joint Committee submission to the ACT Government’s Review of the Application of Environmental, Social And Governance Issues to Territory Investment Practices. 31 http://www.asx.com.au/supervision/governance/Submissions_on_review_of_principle.htm 32 http://www.asx.com.au/about/pdf/mr20070402_revised_corporate_governance_principles_start_dat.pdf



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5.3 Australian Council of Super Investors The Australian Council of Super Investors (ACSI) is a not for profit organisation formed in 2001 to provide independent research and education services to superannuation funds. It comprises 41 member organisations, with funds under management totalling approximately $175 billion on behalf of nearly 8.9 million superannuation scheme members.33 In 2005-06, ACSI reported that it had become a signatory to the UN PRI, and foreshadowed its intent to initiate engagement with companies to take into account material ESG risks within traditional analysis. In December 2006 and January 2007, ACSI conducted a survey of its members to find out their knowledge of, and activities being undertaken in relation to, ESG issues generally, and the UN PRI in particular. The purpose was to assist ACSI to identify activities that it could undertake to best support its members in integrating ESG issues into investment decision-making processes, and to provide a ‘snapshot’ of activities to date. Of ACSI’s 39 members at the time, 24 funds participated in the survey.34 There was considerable interest in ESG issues and good intentions to do more to consider such issues in investment processes. All respondents to the survey recognised ESG issues as posing risks to investments but many funds felt that they lacked the skills and/or resources to currently integrate ESG issues into their investment decision-making processes. Some funds declined to participate in the survey because they had not considered ESG issues at all, and some funds were actively working to fully integrate ESG considerations across all aspects of their operations. Importantly, the latter funds identified a need to learn more about this complex issue, and found the UN PRI “to be a particularly valuable resource as a place to collaborate with, and learn from, others in Australia and internationally”.35 Funds that held investments in pooled trusts (like the Territory’s SPA and TBA) tended to be unsure about how to integrate ESG considerations in their investment processes, since they have less ability to direct fund managers on how to vote or undertake other activities. Some smaller funds identified resourcing constraints, and their need to focus on member investment returns. The survey certainly confirmed that Australian superannuation funds are at different levels of awareness and adoption of ESG considerations as part of their decision-making investment processes.36

33 http://www.acsi.org.au 34 http://www.acsi.org.au/dsp_viewcontent.cfm?news=2&nid=101 35 http://www.acsi.org.au/documents/ESG%20Survey%20Report%20(website).pdf 36 ibid.



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6. Investment Decision-Making Framework There has been debate around the globe as to the extent to which the fiduciary duties of an institutional investor allow for consideration of ESG issues as part of the investment decision-making processes. Generally various forms of regulatory legislation/regulation apply within a jurisdiction, and this section of the report briefly looks at some key aspects of this framework in Australia.

6.1 Territory Investments – SPA and TBA The Financial Management Act 1996 (FMA) broadly refers to the exercise of responsible financial management across the Territory’s operations, including prudent management of fiscal risks arising from the management of the Territory’s assets and liabilities. The FMA also sets out specific requirements relating to the use of derivatives in the investment process. Budgets prepared by the ACT Government are required to take into account “the principles of responsible financial management”, including “managing prudently the fiscal risks of the Territory”, which in turn includes “risks from management of the Territory’s assets and liabilities”.37 Furthermore, the chief executives of ACT government departments are responsible for ensuring adequate controls are exercised over assets and liabilities.38 Importantly, Section 38 of the FMA stipulates that the investment of TBA moneys “may be made…only to increase or protect the financial wealth of the Territory”.39 This provision does not apply explicitly to SPA investments but implicitly it is a principle that should apply to all Territory investments, including the SPA. Territory investments are not regulated by any external bodies. The Board notes that the implicit fiduciary duty of the Government and the chief executives of ACT government departments is to act in the best interest of the Territory (and its taxpayers) in a similar manner to that of large institutional investors, including trustees administering the investments of superannuation schemes. In its submission to this review, the ACT Greens stated:

“The Greens recognise that the primary objective for the ACT Government in investing its funds is a competitive financial return, commensurate with the risks taken. However, the Greens believe that while pursuing this objective, the ACT should not lose sight of broader issues.”40

37 Section 11 of the Financial Management Act 1996 38 Section 31 of the Financial Management Act 1996 39 Section 38 of the Financial Management Act 1996 40 ACT Greens submission to the ACT Government’s Review of the Application of Environmental, Social And Governance Issues to Territory Investment Practices, p. 1.



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6.2 Investment Decision-Making Framework for Other Types of Institutional Investments

The Freshfields Report, being the landmark report that it was, describes the framework for investment decision-making in Australia. In coming to its conclusions, the Freshfields Report observed that there are three main types of institutional investment occurring within Australia, being Superannuation Funds, Statutory Funds of Life Insurance Companies and Managed Investment Schemes.41 As reported in the Freshfields Report, the Corporations Act 2001 [Cwlth] contains a number of statutory duties that apply to all companies and their directors and officers. In terms of investment decision-making, these statutory duties require that directors and officers:

“exercise the degree of care and diligence that a reasonable person would exercise if they were in the company’s position;

discharge their duties in good faith and in the best interests of the corporation and for a proper purpose; and

act in good faith, honestly and not improperly use their position or information”.42

Superannuation funds are also required by legislation to incorporate specific responsibilities in a fund’s trust deed. As summarised in the Freshfields Report, the Superannuation Industry (Supervision) Act 1993 [Cwlth] (SIS Act) provides that the governing rules of such a trust must contain the following duties applicable to the trustees:

“act honestly in all matters affecting the entity; exercise the degree of care, skill and diligence that an ordinary prudent person

would exercise in dealing with the property of another for whom the person felt morally bound to provide;

act in the best interests of beneficiaries; not do anything that would impede the proper performance of its functions and

powers;

formulate and give effect to an investment strategy that considers the whole of the circumstances of the entity, including but not limited to (1) the risk involved in making, holding and realising, and the likely return from, the entity’s investments having regard to its objectives and its expected cash flow requirements; (2) the duty to diversify investments; and (3) the ability of the entity to discharge its existing and prospective liabilities to manage reserves responsibly; and

allow a beneficiary access to certain information”. 43, 44

41 Freshfields Bruckhaus Deringer, op.cit., p.40. 42 See Sections 180, 181 and 184 of the Corporations Act 2001 [Cwlth]. 43 In the absence of express provisions, Section 52 of the SIS Act provides that such covenants will be deemed to be included in the governing rules of the fund. 44 Freshfields Bruckhaus Deringer, op. cit., p.41.



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Additionally, the SIS Act requires that the trustees of a regulated superannuation fund “…must ensure that the fund is maintained solely for…the provision of benefits for each member of the fund…”.45 In February 2001, the Australian Prudential Regulation Authority (APRA) released Superannuation Circular (No.III.A.4) relating to the sole purpose test. The sole purpose test requirements ensure that the maximum retirement income objective is paramount for superannuation funds, and for those administering these funds.46 The regulatory bodies that oversight the institutional investment sector in Australia include APRA and the Australian Securities & Investments Commission (ASIC).

6.3 Case Law As of October 2005, there was no reported case law in Australia that had dealt with the fiduciary duties and the implementation of SRI into investment decision-making processes. English cases are likely to provide the best guidance on how the matter might be dealt with by Australian courts.47 The Board is not aware of any reported Australian case law since October 2005 dealing specifically with this issue. In 2003 the Queensland Investment Corporation (QIC), the investment arm for the Queensland Government, provided guidance to its investment clients in regard to QIC’s investment policy on SRI at the time. The report issued in May 2003, entitled ‘Socially Responsible Investing – A Review of the Industry and Current Products’ is believed to be the only contemporary published report of an Australian government entity’s consideration of these issues. The report identified a number of issues that needed to be considered by Trustees, and included the following:

“The legal capacity of a fiduciary to invest the funds entrusted to it does not extend to the utilisation of those funds for purposes other than investment. Funds may not be held or used for the principal or dominant purpose of advancing social or ethical goals, however laudable they might be.

The principal source of case law for this is Cowan vs Scargill, (known as the Scargill Case) a 1984 UK case, decided on appeal in 1985. Under a mineworkers’ pension scheme set up by the National Coal board, a committee of ten trustees was formed, five appointed by the Board and five by the National Union of Mineworkers (NUM). Part way through the fund’s life a revised plan for investments was tabled but the NUM trustees refused to approve it unless their own (and separate) amendments outlawing, inter alia, oil and gas investments (irrespective of return), were incorporated. They maintained these objections were matters of principle and were part of union policy as determined at the union’s annual conference. Discussions between the Board and the union trustees went nowhere and in 1984 the Board Trustees went to court seeking to establish that the union trustees were in breach of their fiduciary duty. The court held that they were in breach and that the

45 See Section 62, Superannuation Industry (Supervision) Act 1993 [Cwlth]. 46 http://www.apra.gov.au/Superannuation/Superannuation-Circulars-and-Guidance-Notes.cfm#circ 47 Freshfields Bruckhaus Deringer, op.cit., p.44.



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duty of trustees was to act in the best interest of their beneficiaries. If the purpose of the Trust was the provision of financial benefits (which it was) a power of investment had to be exercised so that their funds yielded the maximum returns possible (judged in relation to the risks of the investments). This was held to be so, whatever might have been the trustees’ personal views or their moral reservations on the choice of the most suitable investments.

This case is of strong legal precedent in Australia and still casts a long shadow over fund trustees, in relation to decisions over the choice of investments for superannuation funds that were set up to provide financial benefits for members”. 48

Many commentators, particularly those supporting SRI investments, have been critical of the Scargill case. Some members of the investment community have interpreted the decision of the Scargill case as providing the authority for:

“…imposing a duty to obtain the maximum rate of return possible, effectively precluding trustees and their fund managers and advisers from having regard to any considerations, other than the maximisation of financial returns”.49

The Freshfields Report noted that the presiding judge in the Scargill case issued a later paper in 1989 analysing his own decision and offered some suggestions that integrated the dual considerations of ethical and financial criteria.50 In a later case Bishop of Oxford v Church Commissioners [1991] PLR 185, the English court considered whether trustees could adopt an investment policy that excluded investment of a church trust fund in South Africa. In summary, the Court found that that trustees could accommodate the views of those who considered that on moral grounds a particular investment would be in conflict with the objects of the trust, so long as the trustees were satisfied that this course would not involve a risk of significant financial detriment.51 Based on accessed research, it is reasonable to conclude that trustees cannot determine investment policies on the basis of ‘ethical’ considerations alone. A trustee has an overriding responsibility to protect the corpus of the trust fund and to invest it in a way that puts the money to highest and best use within the context of the rules of the trust and the applicable law. Nonetheless, as long as the financial interests of members remain paramount, there is strongly emerging opinion that ESG considerations could, or possibly should, be incorporated into investment decision-making processes.

48 http://www.qic.com.au/qicnet/, Socially Responsible Investing Report May 2003.pdf 49 Freshfields Bruckhaus Deringer, op.cit., p.88. 50 ibid., p.9. 51 http://www.acsi.org.au/documents/Newsletter_5_(Special_Edition).doc, p.27



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7. Terms of Reference #1 The Terms of Reference require the Board to:

Consider the various approaches to ‘ethical investment’ including socially responsible investment, sustainable investment and corporate governance responsibility.

There are several ways in which ESG considerations may be systematised in operational aspects of investment. The approaches generally fall within a ‘values’ or a ‘risk’ approach, or a combination of the two. ESG investment traditionally was considered using a values-based approach, reflecting the desire to invest along certain moral lines that dominated the mind-set of investors, eg banning investments in the armaments or tobacco industries. This approach has also been called socially responsible investing (SRI). To date, investment in SRI products has been small. In 2006, SRI funds’ market share in Australia has been reported at 1.54 % compared with 1.14 % in 2005.52 A risk-based approach to ESG broadly refers to shareholder engagement of the management of a company in the form of a constructive dialogue whereby key ESG exposures are raised and considered in an active manner. Engagement is consistent with an investment framework within which the shareholder acts like an owner, monitoring the company closely, and engaging in dialogue with the company on key issues where necessary. As noted in Section 4.3 above, the risk-based approach to ESG investment has also been slow to evolve. Influencing factors have included institutional investors concerns about the legality of taking into consideration ESG factors and the different investment horizons of participants in the institutional investment market. To date the prime focus of ESG investment has been on listed equities, ie shares publicly traded on a stock exchange. This report focuses on this particular class of investments, but notes that the application of ESG considerations to investment decision-making processes can equally apply to non-listed investment classes such as fixed income securities, debt instruments, private equity and direct property.

7.1 V