The headlines have recently been dominated by loud voices from around the world calling for political cooperation and action on climate change risks. The theatrics of the Extinction Rebellion protests and the resonance of Greta Thunberg speaking to power have kept the issue in the public psyche.
Yet it might be that a judge in the Federal Court of Australia’s interpretation of superannuation supervisory statute and trust law result in a more significant shift in how the economy responds to climate change risks.
Trustees of Australian Prudential Regulation Authority (APRA) and self-managed superannuation funds alike should pay close attention to the upcoming case of McVeigh v REST, and the possibilities of either setting a precedent requiring consideration of climate change as a material investment risk or highlighting the need for more specific climate change risk focused regulation.
A WORLD FIRST
McVeigh v REST is important, as it will test the issue of whether a superannuation trustee has a legal duty to consider climate change-related risks when exercising its discretionary investment powers. It’s also unique as it’s a first in testing the law as it relates to superannuation or pension fund trustee duties and climate change risk.
Importantly, the case deals with a member with a long-term investment horizon, who defaulted into the fund and has not provided the trustee with instructions on how he wished his investment to be managed. Any judgement would be likely to relate to similar circumstances, rather than covering superannuation trustee duties generally.
While there is relevant case law which is likely to be relied on in the judgement, the question of whether the standard of care required of a professional superannuation trustee requires that the trustee identify and consider climate change as a specific financial risk has not been tested in court.
There are no specific statutory obligations which require climate change to be considered as a financial risk when exercising investment powers, however there are clear obligations of trustees to identify, monitor and manage material risks to investments generally.
The prudential framework includes binding standards which prescribe certain material risks to be identified and managed as part of a superannuation trustee’s risk management strategy. While the standards don’t include climate change as a mandatory material risk, it does require that any other material risks are identified by superannuation trustees.
NOT ABOUT RESPONSIBLE INVESTING OR ETHICS
The case has been carefully framed through the lens of climate change being a financial risk, so it’s unlikely to focus on precedents related to ethical or responsible investing and the related questions of alignment with financial outcomes as the proper purpose of the exercise of trustee duties.
The case is focused on interpreting trustee duties in an environment where there is no conditioning of the best interests obligation beyond the foundational interpretation in the 1980s British case of Cowen v Scargill of the best interests of members of a superannuation or pension fund usually being their financial best interests.
There is a strong foundation of accepted analysis which identifies the macroeconomic risks that climate change poses. As large, long-term investors, the financial performance of superannuation funds is generally correlated to the long-term performance of the economy.
However, there is an inherent reluctance for courts and regulators to interfere with the broad discretions of superannuation trustees to invest and manage investment risks as they see fit. This approach has the benefit of ensuring flexibility in complex environments with dynamic risk factors.
WHAT WOULD A DECISION IN FAVOUR OF MCVEIGH MEAN FOR SUPER TRUSTEES?
Should the case be decided in McVeigh’s favour, it could create a binding interpretation and precedent of the law as it relates to superannuation trustees’ discretionary investment powers in circumstances akin to those of McVeigh. Specifically, where the member has defaulted into a MySuper product, not having provided any instruction to the trustee concerning investments.
While such a decision would require trustees in a similar position to identify and consider climate change as an investment related risk, it would not prescribe any approach to addressing the risk.
Trustees would still then need to determine whether the risk is best controlled though divestment from certain assets (such as coal), focus on impact investments (like carbon capture), or the use of its role as shareholder to advocate for changes in the manner assets operate.
While many large superannuation funds already have robust stewardship and environmental, social, and governance (ESG) risk factor aspects to their investment governance frameworks, a decision in McVeigh’s favour would be likely to focus these arrangements on ensuring that climate change aspects were integrated.
WHAT WOULD A DECISION IN FAVOUR OF REST MEAN?
On face value, it would be easy to see a decision in REST’s favour providing certainty that there is no specific legal obligation for superannuation trustees to identify and manage climate change as a material investment risk. Importantly, such a decision would not restrict of prohibit superannuation trustees from identifying and managing climate change as a material investment risk.
Furthermore, a decision in REST’s favour may also identify the need for the regulator or Parliament to update the relevant law (in the prudential framework) to achieve the outcome which McVeigh is seeking.
In addition to its supervision role, APRA is a lawmaker with delegated authority to make and amend regulations and prudential standards under the relevant legislation.
If the case was to be decided against McVeigh, APRA has the power to amend the existing risk management prudential standard (if it wished) to require that superannuation trustees considered climate change as a material risk for the purposes of their risk management framework.
Alternatively, a legislative approach similar to that adopted to modern slavery could be pursued to require superannuation trustees (and other long-term investors) to identify, address, and report to regulators on how climate change related risks were being managed. This would require the political will, however.
A SIGN OF THINGS TO COME?
The growing importance and influence of large asset owners such as superannuation trustees is likely to continue to attract the attention of activists with a broad range of views and issues. While this case is clearly focused on the role of climate change through the lens of financial performance, the positive and negative impacts or externalities resulting from the investment decisions of superannuation trustees are likely to see future scrutiny and debate.
Jonathan Steffanoni is a partner at QMV Legal.
