Volkswagen faces major lawsuits from investors and shareholders for the losses (more than 25 billion euros in the stock market value) caused by the scandal on emissions cheating devices. Now imagine if companies were held responsible for ignoring the risk of climate change in their investment decisions. The problem is very real, as pension funds in particular could be accumulating assets that in the long run will not earn financial returns.

“Climate change represents an overlooked risk in financial markets that could substantially affect the valuation of many publicly listed companies,” warns the Centre for International Governance Innovation, a think tank in Canada. But not enough is done to manage portfolios accordingly. The Principles for Responsible Investment (PRI), a UN initiative that promotes environmental and social sustainability in the financial sector, argues that despite recent progress, many assets are still handled “with a 20th century mindset”.

At the core of the matter, there is the principle of  ‘fiduciary duty’, which is meant to ensure that those who manage other people’s money act in the interest of the beneficiaries. “It is the same relation of doctors and patients,” says Alice Garton, financial lawyer at non-profit group ClientEarth. “Boards of directors should consider all risks when managing their companies, and these include climate change.”

The legal interpretation of fiduciary duty varies according to countries regulation and, in narrow terms, it has been associated to the ‘duty to seek profitability’. A recent report by PRI and the UNEP Finance Initiative, however, clarifies that “long-term value drivers”, such as climate change risk, also pertain to fiduciary duty.

Nathan Fabian, director of policy and research at PRI and former CEO of the Investor Group on Climate Change, explains: “We know that the decarbonisation of the economy will impact asset values, changes in the climate will have physical impacts on assets, and policy and technology shifts will impact companies performance, economic competitiveness and financial returns. As a result, climate change influences the fulfillment of fiduciary duty.”

In practice, boards of trustees should have processes in place to assess the risks and implications of global warming and address them in investment strategies. “This means taking information from appropriate sources, such as the scientific community, policy experts, economists and increasingly investment analysts who are writing about the risks and opportunities of a low carbon economy,” continues Fabian. Companies also have the obligation to prepare financial reports which inform investors about business risks.

So who could file a lawsuit? “A whole range or stakeholders,” says Garton. “From shareholders to members of pension funds to the liquidators of companies who have become insolvent as a consequence of poor decisions on climate risk.” Typically the target of the action will be boards of trustees and companies directors. An example is the case brought in the US against Arch Coal, one of the largest producers of thermal and coking coal. Members of the employee pension plan sued trustee, directors and officers for directing the contributions of the employee’s pension fund to the company stock, which “plummeted in value by 96%” over three and a half years. It appears that when making such decisions, no one could see that the US coal industry was in “structural decline.”

“Some companies have not fully considered the implications of the transition to a low carbon economy and what this means for their business, so information in the market is not calibrated to a safe climate outcome,” says Fabian. “Other obstacles are an over reliance on assessing financial performance in short time frames and uncertainties on government policies.”

Both Fabian and Garton say that further guidance should be provided from financial regulators to reflect the new understanding of climate change risks and fiduciary duty. “The extent of climate change and the impact on social systems will gradually influence the public mood and the awareness of investment professionals. If investors move quickly after the Paris conference, setting up proper processes, they will be doing the right thing. Beyond that, it is difficult to predict what could happen,” concludes Fabian.