Model Mandate Part 3: Before negotiating mandates
Understanding fiduciary duties and regulatory requirements
Fiduciary duty is at the core of investor stewardship. Fiduciary duties exist to safeguard the current and future interests of beneficiaries, and are fundamental to the development of stewardship policies and practices. It is vital that asset owners adopt investment strategies and stewardship practices which allow them to meet, and are compatible with, their fiduciary obligations.
Asset owners may have to balance potentially competing interests across different beneficiary groups, particularly when managing assets to cover long-term liabilities with different maturities. By their very nature, certain asset owners such as pension funds and insurers are more likely to have a long-term approach for their investments.
A primary obligation of investor fiduciaries with long-term liabilities is to align investment practices with the creation of long-term, sustainable value – for example, by identifying investment opportunities arising from the SDGs - while minimizing risks that could impact future returns. This should include material sustainability and ESG risks.
The ICGN Guidance on Investor Fiduciary Duties (2018) provides general guidance to investors on how fiduciary duty relates of a range of factors, including investor governance, systemic risks and fiduciary duties throughout the investment chain.
Asset owners cannot discharge their fiduciary obligations to their end beneficiaries simply by hiring an asset manager. They may delegate investment tasks to asset managers, but fiduciary duty itself is a core stewardship concept that cannot be delegated. It is therefore essential that asset owners take steps to ensure that their managers act in a way that is consistent with the owner’s fiduciary obligations – including in the design and monitoring of their mandates.
In addition to their underlying duties, asset owners and managers are increasingly subject to requirements set out in legislation and regulation, standards and stewardship codes that will influence how they invest their assets and how they report publicly and to their clients and beneficiaries. For example, one recent trend in regulation has been the introduction of the concept of ‘double materiality’, whereby companies are expected to consider and report on external environmental and social impacts of their activities as well as internal impacts on the company’s own financial performance
Fiduciary duties and regulatory requirements will differ between categories of asset owners and between markets, and investors investing in multiple markets may be subject to a range of local requirements that are not always entirely compatible.
A Legal Framework for Impact: Sustainability Impact in Investor Decision-Making a 2021 report by PRI, UNEP FI and the Generation Foundation, provides a comprehensive legal analysis of the extent to which investors are required or permitted to invest for sustainability impact in 13 different jurisdictions.
It is important that asset owners have a clear understanding of the various obligations to which they (and their asset managers) may be subject when making investments. It is good practice to review regularly – for example, once a year – whether there have been any changes in these requirements.
Developing an investment strategy
The investment strategy should set out the asset owners’ investment beliefs, the desired outcomes and, in broad terms, how they will be achieved. In many respects this is the most important stage in the process as the strategy will subsequently determine the investments that are made and how they are overseen.
When developing their strategy and beliefs, asset owners should take into consideration: their fiduciary duties and any relevant regulatory obligations; the needs of their clients or beneficiaries; the period over which their liabilities extend; the different factors that could affect the value of their portfolio; and their available resources and capabilities.
The process of developing the investment beliefs and strategy should therefore be robust. One good practice that should be considered is some form of consultation with clients, beneficiaries, and other key stakeholders so that their perspectives are understood before the strategy is finalised. It is good practice to review the investment strategy at regular intervals as priorities and external factors are likely to change.
It is at this stage of the process that decisions should be taken about the overarching sustainability outcomes that the investor is seeking to achieve, for example by identifying which SDGs or sustainability themes to prioritise. For asset owners this might, for example, include setting a target for the percentage of assets to be allocated to investment in the SDGs, or specific SDGs, as well as ensuring that their portfolio has a net positive impact. For asset managers this might, for example, include developing financial products and services and stewardship activities that are specifically designed to address SDGs.
Contents of a typical investment strategy
Implementing strategic policies and procedures
Asset owners will typically have an investment policy or policies which sets out how the principles in the strategy should inform individual investment decisions and how investments will be managed and monitored. These will often address, for example, asset allocation, investment parameters, the use of benchmarks and counterparties and other topics. These should set out at least in general terms the approach to sustainability and stewardship.
Some asset owners will also include detailed expectations in relation to sustainability and stewardship issues addressed in this Model Mandate. Others prefer to address them in separate responsible investment and / or stewardship policies and guidelines, either for the entire portfolio or for individual mandates. These will typically address not only the basis on which investments are to be selected but how the asset owner – or their manager where activities are delegated – will exercise stewardship over their investments.
There is no preferred practice; the important thing is that the asset owner’s policies on these issues should be clearly set out in writing so that they can be shared with current and prospective asset managers, and with the asset owner’s clients and beneficiaries.
Contents of a typical Responsible Investment Policy or Guidelines
[If these topics are not addressed in the overall investment policy]
Designing mandates and asset manager selection
For each individual mandate, asset owners should develop a detailed specification that fits their requirements and which clearly describes their expectations for the way in which investment decisions are made and how the asset manager exercises stewardship on the owner’s behalf. They should ensure during the selection process that they obtain the information they need in order to assess whether an asset manager is capable of meeting those requirements.
As well as the tailored specifications for individual mandates, some asset owners have developed asset manager assessment processes that are applied to all mandates of a certain type, for example by setting minimum criteria related to sustainability that managers must meet to be considered for SDI or impact investing mandates.
PRI’s Investment Manager Selection Guide provides more detailed guidance on the three stages of the selection process: longlisting, shortlisting and in-depth due diligence.
Source: Investment Manager Selection Guide; PRI
Key to successfully matching an asset manager to the mandate is the Request for Proposals (RFP) and the accompanying due diligence process. While all RFPs will have some elements in common, the content should be tailored to each specific mandate to take account of factors such as asset class, investment horizon and the weight to be given to sustainability considerations.
- Appendix A contains examples of information related to sustainability and stewardship that asset owners should consider including in their specifications and seeking from asset managers during the due diligence process.
PRI has published a series of more detailed ESG Due Diligence Questionnaires covering a range of asset classes and stewardship topics.
Asset owners should also ask potential asset managers for their standard terms in order to compare them with the example contract terms in this Model Mandate as part of their assessment of a manager’s suitability. This can be particular useful when investing in pooled funds or other circumstances where the ability to negotiate different or additional terms may be limited.
Negotiating the Investment Management Agreement (IMA)
Asset owners should be clear and realistic about their ability to negotiate the exact terms of the investment management agreement. Asset managers will typically have standard terms for their investment products, and while many are willing to vary these terms to a degree or agree to additional terms in an appendix or side letter this will not always be the case (for example, if the product is a pooled fund). In addition, in some jurisdictions there may be regulatory constraints on the asset manager’s ability to negotiate variations to their standard mandate terms.
Asset owners should also determine whether the sustainability and stewardship services that they require are part of the standard terms, and therefore covered by the fee for managing the mandate, or whether the asset manager considers such services to be optional extras which will require additional fees. This information should be sought during the RFP process.
This negotiation is also an opportunity to define the specifics of information reported by the asset manager. Reporting requirements might include terms related to frequency of reports, reporting on sustainability attributes and impacts within portfolios and updates on stewardship activities. Defining reporting terms within the mandate will help with regular review of asset manager performance.
Reviewing mandate and asset manager performance
The consideration of stewardship and sustainability issues should be integrated in asset manager selection, appointment, monitoring, and evaluation processes. This applies to existing mandates as much as it does to the awarding of new ones. These issues should be assessed when evaluating a possible extension or renewal of a contract with an asset manager. In addition, if the asset owner’s own sustainability objectives and policies have been updated since the mandate was awarded, they may wish to consider discussing with the manager at this stage in the process whether there is scope to adjust the mandate or issuing formal guidelines and/or reporting expectations to them.
Asset owners should review whether they have the internal capabilities to undertake the necessary monitoring. Where asset owners engage consultants or advisors they should also review the objectives and service level agreements with these consultants to ensure that they will support the asset owner in holding asset managers accountable on sustainability and stewardship issues.