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Climate change – a legal risk that fund managers can’t ignore

February 4, 2020

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Climate change is an increasingly topical issue, with its effects continuing to make headlines in New Zealand and overseas.

The Climate Change Response (Zero Carbon) Amendment Act 2019 establishes a framework for New Zealand to contribute to the global effort to limit temperature rise, and to prepare for and adapt to climate change. Very important, but also very abstract (at least at this stage). For fund managers, though, there are already direct legal obligations that can’t be ignored. These obligations are easier to understand when you look at climate change in a different way: by considering its financial effects, rather than its environmental effects.

 

A fund manager’s duties

Fund managers must do what they say they will do. If not, liability can arise for false or misleading statements. This could be under the specific rules for PDSs and register entries, or under the general “fair dealing” provisions of the Financial Markets Conduct Act 2013.

 

This means funds with investment mandates that include environmental, social and governance (ESG) considerations, or whose fund managers make active statements about environmental matters, must honour them. This also means care needs to be taken when describing investments as “green” (on this point, the Financial Markets Authority consulted last year on green bonds and responsible investment products and we’re expecting final guidance soon).

 

However, there are also broader duties for all fund managers to consider.

 

Managers of retail investment funds have statutory duties to act in the best interests of scheme participants and to act with the care, diligence and skill of a prudent person engaged in that profession. These duties are imposed by the Financial Markets Conduct Act and included in all governing documents for retail funds. Similar duties generally arise in one way or another for wholesale funds.

 

There is extensive New Zealand and overseas case law on the duty to act in the best interests of scheme participants, and comparable concepts. In the context of an investment fund, and investment decisions, it is best thought of as a duty to pursue the best possible long-term investment return having regard to the nature and composition of the fund (and in particular its risk profile).

 

The duty to act with a professional standard of care, diligence and skill is related in this context. Amongst other things, it means that fund managers need to properly assess the risks facing their investments.

 

Considering climate change risk

In our view, failing to acknowledge the potential impact of climate change leaves a fund manager at risk of breaching their legal duties. It is no longer possible to discount the issue on the basis that a fund doesn’t have a specific ESG focus.

 

Unfortunately, a one size fits all approach to recognising climate change risk doesn’t work. The level of risk will depend on the fund’s characteristics. For example, climate change risk is potentially more significant for fund managers making large direct property investments than it is for fund managers investing in a diversified portfolio of listed equity (although there is debate about whether climate change risk is properly reflected in market prices).

 

Ultimately, the actions that fund managers need to take will depend on how much of a risk climate change poses to their funds. When making that assessment, it’s important to consider flow-on effects like changing consumer preferences as well as obvious environmental effects like sea level rise.

 

For some fund managers, simply recognising that climate change is a risk that could in the future become material and that it requires ongoing review and assessment will be enough, at least for now.

 

By comparison, where climate change is or could be a material risk, identifying the specific issues, developing a risk management strategy, and disclosing the risk to investors might be needed. These matters probably flow through to the fund’s SIPO, given the FMA’s expectation that a SIPO should be a complete, standalone picture of a fund’s investment policy and objectives. In some cases, a proper consideration of climate change risk might tip the balance for or against a particular investment.

 

Watch this space

This is an emerging issue that will becoming increasingly important over the coming years. We are likely to see some degree of regulatory change in this area (last year, the Government consulted on climate-related financial disclosures that might apply to some in the wider financial services sector). The financial risk of climate change must also be considered in the context of non-financial expectations and changing investor sentiment. Fund managers who fully embrace the issues will be better placed to respond as expectations change.

 

Get in touch!

Anthony Harper‘s specialist financial services team are independently recognised as experts in investment funds, and regularly advise fund managers on these and other issues affecting their businesses. If you have any questions, or need assistance with these issues, please get in touch:6

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