How to Reconcile Profitable Investment and Sustainable Investment?

For several years, the trend has been towards the emergence of an investment that is not only profitable, but also socially responsible. However, considering the difficulty of changing human behaviors, a sensitive question arises: can we truly reconcile profitable and sustainable investment? To address this issue, one enlightening way is to focus on the articulation between the extra-financial duties of companies and investors. How do these regulations meet and do they truly change the behaviors? In fact, there are strong interferences between sustainable governance and sustainable investment, which highlight how far the global normative framework has really evolved.

Without claiming exhaustiveness, the question can be approached through three successive points: the convergences between extra-financial duties of companies and extra-financial duties of investors (1.), the limits of these two regulations (2.), and the prospects for the future (3.).

There is no doubt that nowadays both corporate and investor regulations require extra-financial duties.

From the corporate law side, it clearly appears that through extra-financial reporting and taxonomy, companies are now fully prepared to attract sustainable investors. This reporting is an important key to dialogue with investors and all stakeholders. By all appearances, the legal framework is very encouraging in this connection.

We can mention in this respect the forthcoming CSR Directive¹ which covers smaller companies (including listed SMEs), broadens the scope of extra-financial reporting and clarifies the information due. On the other hand, Taxonomy Regulation² is a very effective transparency tool that facilitates investment decisions and helps combat greenwashing by providing a classification of environmentally sustainable investments in economic activities that also respect minimum social safeguards. The Taxonomy Regulation can thus serve as a guidance tool for companies to attract sustainable financing for their remediation plans and roadmaps (by providing a common language for sustainable economic activities for investment purposes). It is designed to clarify which economic activities contribute most to achieving the environmental goals of Europe’s Green Deal. The taxonomy is so designed to provide investors with a common benchmark, which they can use to invest in truly sustainable companies.³ The legal framework thereby appears to be very promising.

Things are quite similar on the investor regulation side. Here again, we can see that investors are required to comply with extra-financial reporting on their investment decisions. The legal framework of investment organizations is gradually shifting towards the ecological and climate transition. One example is the highly symbolic reformulation in 2019 of the AMF’s (Autorité des Marchés Financiers) supervisory mission,⁴ in order to include the information due by investors on the management of risks related to the effects of climate change.⁵ But the most significant current evolution has been the Disclosure Regulation (SFDR)⁶ requiring, at the level of investment actors, the publication, on their website, of policies on sustainability risks in investment decisions,⁷ which also seems very promising.

Now, how do these two regulations fit together? Apparently, the objectives are totally converging.

A “profitable” company increasingly appears to be a socially responsible company. In the view of many investors, polluting companies are no longer profitable. They seem to be unable to survive without engaging in the ecological transition and they even risk losing their investors in the long run. Conversely, all investors now seem to favor a sustainable approach, because the taxonomy and their own disclosure duties encourage them to invest into sustainable companies. So, in a way, sustainable investment is becoming not the exception, but the very rule, the very model of investment. Meanwhile, the result is strongly enhanced be the remarkable work of the supervising authorities.

Yet there are huge limits. We cannot be naïve: transparency and disclosure of climate and social risks may initiate a new ideological approach to markets, but they are not enough to change behaviors. Neither is soft regulation (e.g. the UK Stewardship Code). Sadly, the fact is that many companies and investors are still, if not directly greenwashing, at least simply managing their own risks instead of truly preventing their negative impact.

Maybe on the corporate law side, reality is slowly changing, companies being increasingly required to do and not just say what they do. This trend is at the very heart of sustainable governance.⁸ So, in a way, shareholder value is no longer the exclusive goal of corporate governance. On the other hand, the investors’ duties are mainly limited to transparency. There lies a real problem. Some experts point out that the primary goal of an investment organization will always be profit and shareholder value,⁹ which implies predominance of the risk/return ratio in the financial decision and prevalence of a narrow conception of fiduciary responsibility (maximization of short-term financial return). In short, the major hurdle is that the fiduciary duty of investors is still exclusively focused on profit. This goal is so strong that it overrides everything else... We have to acknowledge that most funds, including green funds, only target shareholder value. And if we want to change this situation, we have to change their rules, we have to include climate and social risk into their fiduciary duty.¹⁰ In addition, ESG is a vague criterion, not necessarily operational. Currently, there are very few long-term investors. Even those who claim this status do not play the game fully. In practice, the idea of responsible investment is often misused. ESG has become an industry.

Another dimension of the problem is that sustainable investment also implies a long-term shareholder engagement. Investors cannot act sustainably towards climate or employees without engaging sustainably with the target companies. But once again, alarmingly, short-term profit is still prevalent in the fiduciary duty of investors.

However, a real improvement in this area has been made by the Long-term shareholder engagement Directive of 2017.¹¹ The Directive applies to all professional investors and asset managers and seeks to ensure that they “engage” sustainably with the companies in their portfolios, with a view to profitability that respects the company, its stakeholders and major societal causes (environment, climate, etc.). All investment actors must thus establish and publish a shareholder engagement policy describing “the way in which (they) integrate their role as shareholder into their investment strategy”.¹² At first glance, this provision is modest. Of course, it remains only an incentive. The aim is simply to inform the final investors at the end of the chain and to encourage, through “transparency”, investment players to promote a sustainable investment policy. Strictly speaking, it does not oblige to “commit”, nor to practice a long-term shareholding policy. But, some genuinely innovative elements are introduced and the flexibility of the approach does not detract from their importance. At the outset, it should be emphasized that the engagement policy defines in depth the relationship between the investor and the companies held. The approach itself is new, as it expressly refers to the investor as a shareholder. This is a significant development in the regulation of asset managers, which previously focused exclusively on the relationship between the investor and his clients. Finally, despite the stated purpose of transparency, there is a little more here than just transparency. There is an obligation both to say and to do. In particular, before disclosing the required information, the asset manager must necessarily establish an engagement policy. In other words, the investment strategy must include a “shareholder engagement”, which goes beyond the simple voting policy required until now. And this obviously encourages long-term engagement and dialogue with companies. In this respect, the texts determine precisely the expected framework of this policy, which is supposed to refer, for example, to dialogue with companies. The whole thing is undoubtedly more effective than it seems, not to mention the legal consequences of failure to comply with the new obligations (liability, name and shame effect, etc.).

Actually, modest as it may seem, this Directive already triggers effective consequences. One very concrete consequence has been to stimulate climate resolutions, which have become frequent in large listed companies (i.e. Vinci, Total). They are proposed by professional investors, who seek to include them on the agenda of shareholders’ meetings in order to encourage boards to increase their efforts to combat global warming. In general, they aim to impose better shareholder information or a shareholder advisory vote on the company’s climate policies. Strangely enough, the validity of these resolutions has been challenged with regard to the principle of the hierarchy of bodies in public companies (that is to say, the separation of the legal powers of boards and shareholders’ meetings),¹³ which also shows to what extent the legal framework of companies is still under-framed when it comes to these new issues. In any case, this new practice is directly linked to the long-term shareholder engagement Directive. It should be added that these resolutions are supported, and sometimes even come from traditional investors who don’t even claim the ESG label. So the Directive may not be quite sufficient, but it certainly goes in the right direction.

Now, what are the prospects for the future? We can stress two points here.

One very important step towards the effective meeting of sustainable governance and sustainable investment will certainly be the future Directive on Corporate Sustainability Due Diligence.¹⁴ The proposal, dating from last February, aims to prevent and address adverse impacts on human rights and environment (including climate change), throughout all the value chain (subsidiaries and “established” business relationships). The significant fact is that it concerns both companies and investment organizations.

In particular, the Directive specifically applies to all investment actors: funds, pension funds, asset managers, etc., provided they meet the Directive’s thresholds (e. g. more than 500 employees and a net worldwide turnover of 150 million euros during the last financial year). So, the largest of these organizations will have to comply directly with the due diligence. One important fact is that the text also includes large foreign organizations, as long as they operate on the European market (turnover of 150 million euros on the European market). So obviously, this can greatly increase the duties of investors.

A tool of effectiveness is the role entrusted to the board of directors. Whether it is an investment firm or another company, the board of directors is at the heart of the system: not only would the board be entrusted with the implementation and supervision of the due diligence, but it would also be subject to a “duty of care”, which implies taking into account, in fulfilling its obligation to act in the best interests of the company, the consequences of its decisions on “sustainability issues” such as human rights, climate change or the environment.

However, funds and asset managers (like all companies in the financial sector) receive special treatment, which is less demanding than for ordinary companies. They are not part of the high-impact sectors (textile, agriculture, food products, mineral resources, etc.) that justify the application of the directive to smaller companies. Similarly, they are exempt from the obligation to terminate the contract when they fail to enforce due diligence through soft law and contractual clauses and only have to identify their adverse impacts at the inception of the contract. In addition, their value chain is restrictively covered (clients who are individuals or households and SMEs are not included). The question is even whether the clients of an investment organization included in its value chain are only the final investors or also the target companies. Nevertheless, it remains that the due diligence commitment will have a strong impact on both investment policies and shareholder policies and activism. To put it clearly, the very choice of target companies and the shareholder engagement policy must be in line with investors’ due diligence. This goes far beyond disclosure. This is a real duty to do and not just to say. The Directive will so reinforce the Disclosure Regulation (precisely because it goes beyond disclosure). But it is a shame that it only covers large investment organizations.

To conclude, we can mention one more tool which, although not binding, is also encouraging: the development of impact finance, seen as a branch of sustainable finance¹⁵. Impact finance was defined in 2021, by the French Ministry of Economy as finance aimed at reconciling the search for ecological and social performance with financial profit. It aims as well to transform the target companies from the inside. So it truly favors the long-term engagement of investors, because the impact investor needs impact companies and a sustainable dialogue and cooperation. There is therefore hope and reason to remain somehow optimistic, despite the limits of the current legal framework. n