Investment industry's data usage branded incompatible with fiduciary legal duties
Canada’s investment industry is risking lawsuits from “flawed ESG data” according to a legal expert.
In a scathing new whitepaper from the Fraser Institute, Bryce Tingle, N. Murray Edwards chair in Business Law at the University of Calgary puts ESG ratings on notice, warning that the metrics driving trillions in investment decisions are deeply flawed and could land fund managers in court.
In ‘A Lawsuit Waiting to Happen: The Use of Non-Financial Metrics by the Investment Industry’, Bryce argues that reliance on third-party ESG scores is unreliable, costly, and potentially incompatible with fiduciary duty.
He highlights one of ESG’s wildly inconsistent ratings which can mean that the same firm can be ranked as a leader by one agency and a laggard by another. “Many ESG factors are purely subjective, such as employee happiness … [and] incommensurate even across a single dimension,” the paper notes.
This inconsistency undercuts ESG’s credibility as a decision-making tool and far from predicting future performance, the data “fail to forecast environmental or social compliance, operating performance, or stock price trajectory.”
Even governance ratings show no consistent link to financial outcomes with Tingle noting that agencies “cannot even agree on which companies are ‘well governed.’”
According to the paper, corporations can spend up to US$480,000 annually answering rating requests, with some firms hit by as many as 250 surveys per year and boards are increasingly devoting management time to satisfying ESG raters. Tingle concludes that the ESG disclosure treadmill often represents “a dead loss of time and money.”
The biggest warning comes on the legal front with the report highlighting that investment managers are fiduciaries, legally bound to act in the best interests of their clients, but if the tools they use are demonstrably flawed, they may be in breach of that duty.
“Can investment fund professionals, who manage the wealth of other people, legally rely on ESG data in making their investment decisions?” Tingle asks.
The Fraser Institute calls for immediate regulatory guardrails with recommendations including:
- Show your work: “If a fund claims to invest based on ESG considerations, the fund managers should have to show their own work,” the paper insists.
- Draw the line: Regulators should make clear that uncritical reliance on ESG scores is not compatible with fiduciary duty.
With US$3.16 trillion in investments already tied to ESG strategies, the stakes are enormous and without reform, Tingle warns, investors may face misallocated capital, and fund managers could face lawsuits.
