I. Introduction

Over the last century, environmental law emerged, ramshackle but rather ingenious, from legal areas previously devoted to vastly different purposes: nuisance law, property law and equity, to name but a few.1 Joined, in the 1970s, by environmental legislative initiatives in most common law jurisdictions, it helped to improve the quality of air, water and land. For many, the accomplishments of early environmental law were nothing short of revolutionary. Then onto this patchwork backdrop of legal rules and norms, the problem of climate change appeared. The environmental challenge presented by climate change is different to those of previous eras. First, climate change is global: its solution relies on global agreement and local action in order to avert differentiated, localised impacts. It may well require legal foundations that stretch beyond the limits of early environmental law. Second, climate change is urgent: mitigation today is necessary in order to avoid catastrophic consequences in the future. It therefore needs decision-makers to expand and extend their usual frames of reference.

The temporal character of climate change makes it a particularly difficult problem to address. Notwithstanding the difficulties in predicting, with precision, the effects of climate change at any one point in space and time, the bulk of scientific evidence suggests that impacts of climate change will increase in severity of the next century. It requires coordinated solutions urgently, but the cost of these solutions must be borne now in order to safeguard the well-being of future generations. The sort of response needed is a tough sell, both in politics and in the private sector. Shortterm perspectives are ingrained in our psyches and in our institutions: to overcome them we must contend with behavioural biases, the pressures of the electoral cycle, the short-term incentive structures in place in finance, and the tendency of the common law legal system to reinforce the (often short-termist) status quo. Nonetheless, it is possible to create structures (using the law or governance frameworks) that encourage or require longer term timeframes for environmental decision-making.

This thesis brings together two responses to the question ‘how can the law extend the timeframe for environmentally relevant decision-making?’ The first response is drawn from the context of institutional investment, and addresses the timeframe and breadth of environmental considerations in pension fund investment decision-making. Pension funds are the most financially important of institutional investors, the large organisations that invest on behalf of large groups of individuals. Their collective financial holdings are immense. As at December 2010, pension funds in Australia, the UK and the US held assets of 103 per cent of GDP, 101 per cent of GDP and 104 per cent of GDP respectively. As significant owners of domestic equities and bonds, their relationship to the environmental impacts of companies across these economies should not be overlooked. Although pension funds are longterm investors in the sense that they often must prepare to provide retirement income for future retirees at least thirty years into the future, in practice the day-to-day timeframes for investment decision-making tend to be short.

Pension funds usually monitor companies’ performance over quarterly periods; incentives for asset managers are generally structured around short-term results. As a consequence, the investment decision-making with respect to the enormous wealth of pension fund assets often fails to capture long-term considerations. Those businesses that spend more resources on ensuring a better environmental outcome may be less profitable in the short-term, even if their improved environmental impact is financially rewarding in the long run. This combination of factors means that institutional investors direct huge amounts of capital into corporations whose performance is stronger in the shortterm, but whose long-term activities may be worse for the environment. Furthermore, if and when legislation is enacted to internalise environmental externalities (for example, as taxes are placed on greenhouse gas emissions), this long-term failure to improve environmental practices may translate into simultaneous financial weakening.

The second response is related to the context of public environmental decision-making by legislators, the judiciary, and administrators. In the modern democracies that form the setting for this thesis, the United Kingdom (UK), the United States (US) and Australia, political decisions are beset by a preoccupation with the short-term. Political incentives are generally structured around short-term results. Those issues that demand a longer term perspective are often neglected where their demands are in conflict with the requirements of shorter term issues. Decisions affecting the environment often fall squarely within this category. In the context of climate change, for example, while the UK has made considerable policy changes in order to reduce greenhouse gas emissions (though the practical feasibility of this ambitious policy is yet to be proven), the US and Australia have thus far struggled to implement comprehensive policy responses to the problem of climate change. In both of these countries, the politically expedient focus on short-come outcomes (such as the desire to prevent increased energy costs, the reluctance to hamper conventional modes of transport, the maintenance of favour with oil producers and energyintensive industries) has sapped the political will to introduce climate change reduction measures that require any form of current economic sacrifice.

Short-term thinking with respect to institutional investment and policy-making is deeply ingrained, and has an often deleterious effect on environmental outcomes. It is not, however, intractable. This thesis suggests that there are several ways in which laws may help to extend the timeframe for environmentally relevant decisionmaking. The first half of the thesis, which deals with timeframes for decision-making within pension funds, examines the law of trusts (and in particular the concept of fiduciary duty – a duty owed by trustees to take a high level of care in managing the assets of their beneficiaries) as a means of extending the timeframe for investment decision-making. Its starting point is the idea that where asset performance is considered over a longer timeframe, those companies that address longer term environmental concerns may appear more favourable to those who manage institutional investment funds.

Chapter III demonstrates that, traditionally, lawyers, investors and courts alike have interpreted their fiduciary duty as requiring trustees and asset managers of investment funds to focus solely on the generation of profit over an increasingly short period of time. This is wrong. Instead, trustees and asset managers should consider increasing the timeframes over which they assess their investment options, taking into account the social and environmental factors that may affect financial performance over the longer term. Parallel shifts in attitude about what constitutes a worthy consideration when assessing investment opportunities have occurred before; all the evidence suggests that, given the appropriate conditions, they will occur again.

A number of judicial decisions are presented demonstrating how such a change might occur. While Chapter III is infused with the theory behind fiduciary duty, investment decision-making and inertia within common law legal systems, Chapter IV provides a practical application of the theoretical recommendations outlined in its predecessor. It provides a framework outlining how pension funds might implement a longer term, more sustainable approach to investing. It acknowledges the legal uncertainties that persist within the field of fiduciary law with respect to environmental and social concerns, and suggests a structural means (anchored in a particularly explicit approach to governance) for overcoming them.

The second half of the thesis, operating in the context of public environmental decision-making, is centred upon a particularly poignant legal notion with respect to the environment and time: the concept of intergenerational equity. Just as the first half of the thesis deals with the timeframes relevant to investment decision-making by pension funds within the bounds of fiduciary duty, largely a private law affair with public implications, the second half of the thesis is concerned with the principle of intergenerational equity as a means for extending the decision-making timeframe of legislative, judicial and administrative decision-makers. The notion of intergenerational equity is a concept (though some would say ‘principle’) that exists in international law. Its international law incarnation is most often cited as being Principle 3 of the Rio Declaration on Environment and Development (Rio Declaration) (1992), which states that:

The right to development must be fulfilled so as to equitably meet developmental and environmental needs of present and future generations.

As the vagueness of these words suggest, the concept remains, for the most part, broad, general and difficult to enforce effectively. Indeed academic interest in the principle has been mainly normative in nature. Although propagated by international environmental lawyers, its treatment thus far, for the most part, has been unmistakeably philosophical. For this thesis, however, the concept of intergenerational equity has a very tangible potential. As a notion that consciously seeks to balance current interests with future interests (or more accurately, the interests of the current generation with those of future generations), it is a particularly useful proposition when searching for ways to extend the timeframe for environmentally relevant decision-making.

As previous analyses of the concept of intergenerational equity provide little insight into its practical implications when applied to particular factual situation, it was necessary to search for instances of the application of the principle within case law. The search led to Australia, where legislation (heavily influenced by the Rio Declaration) throughout the various Australian states and territories had in fact implemented a ‘principle of intergenerational equity’, stated as follows:

the present generation should ensure that the health, diversity and productivity of the environment is maintained or enhanced for the benefit of future generations.

Like Principle 3 of the Rio Declaration, the Australian principle is general; its interpretation – its practical effect – has been left to the judiciary. Chapter V provides an analysis of what the legal concept of intergenerational equity might require of decision-makers in practice by examining three cases in which judges apply the principle to particular factual situations. It concludes by arguing that the principle of intergenerational equity has the potential to extend the time frame over which administrative decision-makers are required to consider environmental impacts, by requiring the consideration of the cumulative environmental impact of multiple events. It also underlines the potential for the judiciary to use this principle to help overcome the short-term temptations faced by legislators. Notwithstanding the potential for the principle of intergenerational equity to provide a means for judges to weigh the interests of future generations against those of the current generation, the principle has a number of limitations, largely centred around its origins in administrative law; these limitations are acknowledged. In essence, Chapter V sets out the structure of the principle of intergenerational equity as revealed by case law.

Having established in the previous chapters the environmentally detrimental effects of short timeframes in decision-making in both private (investment) and public (administrative) decision-making, as well as setting out two potential legal routes for extending timeframes for decision-making, Chapter VI draws together the threads of argument established in three previous chapters. It does so by conceptualising environmental management as an issue of long-term investment. As such, it draws upon both the legal concepts of fiduciary duty and intergenerational equity to imagine a regime of long-term environmental management. It has particular regard to Edith Brown Weiss’ ‘Planetary Trust,’ a concept that provides an institutional means for giving effect to intergenerational equity. It then tests this conceptual structure in the context of the management Murray Darling Basin. While it finds that the Planetary Trust concept is ill-equipped to deal with intertemporal conflict (in encouraging the maximization of both current and future interests it fails provide an adequate mechanism for adjudicating between the two), this Chapter highlights once again the importance of judges as independent temporal arbitrators.

Chapter VI may seem pessimistic, but it is not intended as an indictment of the concepts raised throughout the thesis. It highlights particular conceptual flaws within the notion of Planetary Trust, but more importantly, it acknowledges that these flaws are amplified in the practical context of the Murray Darling Basin. Far from condemning the legal concepts of fiduciary duty and intergenerational equity as avenues for achieving longer-time frames for environmentally-relevant decisionmaking, it reemphasises the need for such legal approaches. The story of the Murray Darling Basin highlights the near impossibility for a trustee-like body to make decisions that require current sacrifice for future gain without adequate independence. As a result, it strengthens the case for judges as guardians of the future. Justice Weeramantry’s words in the famous Nuclear Tests Case are particularly relevant here: ‘this Court must regard itself as a trustee of the interests of an infant unable to speak for itself’.

Chapter Content

Chapter III

Chapter III was conceived in early 2009, when the world was reeling from the early effects of the global financial crisis and the UN’s Copenhagen Climate Change Conference (seen as the key to defining a post-Kyoto global accord on climate change) loomed large on the horizon. Since then, the gravity and uncertainty surrounding the financial crisis has become less acute, but many of its ramifications continue to be felt around the world (witness for example, continuing raised levels of unemployment in the UK and the US); the threat posed by climate change has, if anything, become more urgent. These crises are, to an extent, linked by their genesis in short-termism: in both cases, governments and industry have fostered short-term financial gain without sufficient regard to longer term social costs of the externalities at play.

UK and US pension funds, with their huge share and bond holdings, have profound potential to influence companies in almost all industries. Pension funds are in some senses natural long-term investors; in providing retirement funding for successive generations of retirees, they are to an extent distributors of intergenerational wealth. However, in practice they often appear to take a short-term approach to investment strategy and fund governance. This chapter finds that these financial behemoths are failing to fulfil their potential to invest in a better future. The chapter argues that the causes for this behaviour are both behavioural and structural. The evidence suggests that trustees have behavioural biases that contribute to a myopic style of fund management, with a concentration on quarterly financial performance. Moreover, the trust law concept of fiduciary duty has been interpreted by judges, lawyers and trustees in such a way as to encourage investing in line with the status quo, preventing pension funds from investing in a more sustainable manner.

Reflecting on the context of climate change and the global financial crisis, this chapter sets out to demonstrate the theoretical potential of pension funds to drive the reduction of firms’ environmental impact, and to expose the practical barriers that stand in their way. It examines first why fiduciary duty is perceived as a barrier to change in investment practices, outlining recent legal developments in the area. It argues that requirements of fiduciary duty have been interpreted too narrowly, and in theory should not be perceived as a legal barrier to pension funds’ consideration of the risks and opportunities associated with climate change: fiduciary duty has been flexible enough to evolve with social expectations in the past (and should be able to adapt to the increasing importance of climate change now). However, in practice, courts, commentators and trustees themselves have had the tendency to interpret fiduciary duty’s requirement of prudence as ‘what the majority of investors do.’

The prudent course of action in this light becomes to maintain the status quo, limiting the potential for innovative strategic thinking with respect to the investment implications of climate change. The uncertainty surrounding the content of fiduciary duty places a practical barrier to investment innovation in this area. Legislative clarification is needed if pension funds are to change their approach toward climate change. Moreover, the focus on fiduciary duty as a barrier to investment innovation in this area masks the behavioural biases toward inertia and short-termism in trustees, which are more insidious and at least as important. These biases, combined with the uncertainty surrounding fiduciary duty, result in a collective action problem: pension funds are unlikely to break with convention unless a significant number of them change their approach simultaneously. Under these conditions, any institutional acceptance of innovation toward a longer term, more sustainable investment strategy that accounts for climate change will take strong leadership from pension funds themselves.

The typically narrow focus of pension fund investment strategy is frequently attributed to trustees’ fiduciary duty. For many years, trustees have interpreted this duty as preventing the consideration of ‘nonfinancial’ issues in investment decisionmaking. Climate change, whose potential economic effects have only recently become a subject of serious and studied discussion, is often perceived as one of these. It is worth noting that ‘climate change’ is of course not a single event with a unitary impact, but rather a phenomenon that entails a catalogue of risks and opportunities, many of which are likely to have a financial impact. All too often, trustees and their asset managers have been unwilling or unable to deconstruct the concept of climate change to find its consequences, instead classifying climate change as a non-financial environmental consideration. This chapter argues that the interpretation of fiduciary duty that sanctions this type of approach is based on outdated case law, and is too narrow. Moreover, to the extent that climate change presents real financial risks which are likely to be exacerbated as relevant legislative reforms (such as a carbon tax) are introduced, pension funds’ consideration of the risks and opportunities associated with climate change in devising their investment strategy should not, in theory, conflict with even a narrow interpretation of fiduciary duty.

The implications to be drawn from this chapter are threefold. First, the uncertainty surrounding pension fund fiduciary duty and environmental considerations, in particular those related to climate change, should be clarified through legislation. Without this clarification, pension fund trustees will have all the impetus they need to shy away from changes they are already reluctant to make. Second, pension funds must re-examine their approach to investment, as they once did at the advent of modern portfolio theory – any move toward a more sustainable investment approach will require funds to act on their own behalf. An adoption of best-practice governance measures will help pension funds to surmount the behavioural barriers to innovation. Finally, a broader point: this chapter allows a brief, and rather dismal, glimpse at how UK and US courts have interacted with the institutional investment industry in the past – in short, they appear to have reinforced the industry’s existing behavioural problems and mutual uncertainties about the application of fiduciary duty in an investment context. In this light, the spectre of fiduciary duty becomes a means to ensure that existing financial norms, of the sort that fuelled the present financial crisis, remain untouched. It should be underlined that 19 latter chapters, particularly Chapters V and VI, investigate the more positive contributions to be made by courts.

Chapter IV

Chapter IV provides a practical application of some of the theoretical concepts outlined in Chapter III. In particular, it sets out a structural framework through which the environmental potential of pension funds might be realised. It begins by pointing out that the recent global financial crisis has given UK and US pension funds cause to consider the suitability of their investment strategy and the adequacy of their governance techniques. While the crisis can provide no certain solutions as to how pension funds should invest, it does reveal shortcomings in some current approaches to investment. Most notably, it underlines the danger of becoming beholden to herd culture in which prudence is judged by reference to convention (that is, what other investors do) (an idea introduced in Chapter III). The crisis also reveals that a constant focus on short-term performance may distract attention from large, latent longer term risks and hazards, to pension funds’ detriment.

In the fallout of the crisis, many pension funds have focused any strategic efforts, understandably, on the question of how to meet their obligations to beneficiaries under conditions of dwindling funds. Some, however, have used the time to consider a more fundamental shift in the way they meet their obligations to beneficiaries. For those pension funds that have chosen to rethink their investment strategies, one approach has been to consider including an aspect of ‘sustainability’ in their investment strategy, whether it be in the form of longer term investment focus, a move toward the integration of environmental, social and governance criteria within mainstream funds, the creation of specialised funds with green themes such as clean water or renewable energy, or some combination of these. This diversity of approaches underlines the flexibility of sustainability as a concept.

The growing consciousness within the business and investment worlds of the idea of sustainability occurs in the context of the historical backdrop of investment practices related to the notion of socially responsible investment (SRI). Many changes have occurred across the broad field of SRI over the past thirty years. The field has grown beyond the negative-screening approach of many early ethical funds to encompass a broader range of investment strategies Most important, perhaps, is a movement (championed by the United Nations Principles for Responsible Investment (UN PRI)) toward integration of environmental, social and governance (ESG) issues into mainstream investment analysis and decision-making. In contradistinction to an ethically-oriented investment approach, UN PRI defines responsible investment (RI) as ‘the integration of ESG criteria into mainstream investment decision-making and ownership practices’, and underlines the business-case justifications for its adoption. This chapter argues that the incorporation of sustainability into investment strategies may be seen to be strengthening and adding to the RI movement through its focus on intergenerational equity and the long-term.

The framework that this chapter presents is intended to serve as a template for UK and US pension funds who wish to invest more sustainably, but who are unsure of the practical requirements of such a change. The framework focuses on the adjustments that should be made to the fund’s strategy and governance in order to achieve a broader (ESG-inclusive) and longer term approach to investing. Acknowledging that the needs of every pension fund are different, the framework is structured as a spectrum, allowing for more or less extensive change to investment strategy and governance. The chapter begins with a brief review of SRI and more recent RI literature, in the context of growing public awareness of the concept of sustainability. It then examines the literature on pension fund governance, arguing the need for more detailed practical guidance for funds moving toward sustainable investing. A framework is presented as a practical means for UK and US pension funds to go about implementing a sustainable investing approach (ESG-inclusive, and long-term focused) through the adaptation of its investment strategy and governance practices (particularly through the formulation and articulation of a clear investment mission and strong investment beliefs). Finally, the chapter outlines the UK and US legal background, first examining how fiduciary duty might affect pension funds who adopt the framework presented, and then looking briefly at potential regulatory enablers of sustainable investing.

Chapter IV acknowledges the extensive terminological debate that exists in the area. It is to be hoped that widespread, successful implementation of sustainable investing or RI would put an end to the need for such debate. That is to say, if over time ESG-inclusive, intergenerationally equitable investing can be shown to be effective and desirable, at some point its goals will become internalised into pension fund investment beliefs systems. At this point, terminology would change: the terms sustainable investing and RI could drop from the lexicon, and the actions they describe would become merely ‘investment’. Behavioural norms have been shown to have a deep influence on the development of legal understandings. Thus, in this situation of changing norms with respect to investment a parallel development might be expected of law. If sustainable investing were to become increasingly conventional, it is arguable that trust law would treat it increasingly as a prudent manner of investing (see Chapter III), obviating the need for inquiry into whether sustainable investing (as opposed to mainstream investment) met with fiduciary standards.

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