ESG and the reasonable investor test under MAR.
By David Berman, Rob Moulton, and Nicola Higgs
Background
Historically, “profit maximisation” has been regarded as the sole (or predominant) objective for investors. Today, however, an ever-increasing proportion of investors have additional/alternative — sustainability (or ESG)-related — objectives[i]. These investors are not seeking profit at all costs — rather, “cleaner” profits that derive from the sustainable/green activities of investee companies. They are perhaps willing to forego some element of (near-term) profit in return for the environmental and societal benefit, brought about by the investee company, that (they hope) will accrue over time. Many such investors will believe that, in the long run, they may in fact end up maximising their returns — on the premise that sustainability-focused companies are more likely to survive (and thrive) in the future, while others will ultimately fail.
In parallel, regulators are striving to address the growing market/investor appetite for corporate ESG-related information. For example, UK-listed companies are shortly[ii] expected to become subject to a requirement to disclose certain climate-related data in their annual financial reports.
The Law
One branch of the “inside information” definition under Market Abuse Regulation (MAR) is the “significant price effect” test, which means “information a reasonable investor would be likely to use as part of the basis of his or her investment decisions”[iii].
The reasonable investor test is relevant to both issuers[iv] (when deciding whether they have a market announcement obligation) and investors[v] (when deciding whether they are in receipt of inside information for the purposes of the insider dealing and unlawful disclosure offences).
Under DTR 2.2.5G:
An issuer may wish to take account of the following factors when considering whether the information in question would be likely to be used by a reasonable investor as part of the basis of investment decisions:
- The significance of the information in question will vary widely from issuer to issuer, depending on a variety of factors such as the issuer’s size, recent developments, and the market sentiment about the issuer and the sector in which it operates
- The likelihood that a reasonable investor will make investment decisions relating to the relevant financial instrument to maximise economic self-interest
Questions/Issues
In light of the continuing shift towards sustainable investing (and with reference to the highlighted wording above), the “likelihood” that the reasonable investor will be motivated to “maximise his economic self-interest”[1] is arguably reducing.
In consequence, this may result in the universe of inside information becoming commensurately larger, with potential systems and controls implications for issuers, for example.
So, what should issuers and investors assume is the reasonable investor’s investment philosophy?
Practical Illustrations
Issuer Perspective Question
A listed issuer (I Plc) has just been informed that it has received a negative diversity and inclusion rating from a well-respected external agency. On the one hand, this information could potentially be relevant to a reasonable ESG-focused investor in I Plc. However, it may be of no real consequence to a pure profit-maximiser.
When determining whether it has a disclosure obligation under Article 17 of MAR, the central question for I Plc is likely to be whether this information would pass the reasonable investor test[2].
But what specie of investor is I Plc to assume to be the reasonable investor here?
Investor Perspective Question
An institutional investor (Alpha Inc.) attends a bilateral meeting with an investee company (X Plc). At the meeting, X Plc discloses the (overwhelmingly positive) results of an externally commissioned ESG assessment, which it has just received.
Alpha is worried that it may have been made an ‘insider’, as these results are not [yet] in the public domain. In practice, Alpha’s assessment is likely to centre around the application of the reasonable investor test.
Again, what should Alpha assume is the investment philosophy of the reasonable investor — ESG-focused or not — as this may well be key to the analysis?
Commentary
There are no easy answers here; and this is arguably more of a policy decision. That said, Latham has had numerous queries from institutional investors who have found themselves in a situation akin to the above example.
One approach would be to take the prudent view that today’s (hypothetical) reasonable investor is increasingly likely to be interested in sustainability; and, therefore, material non-public ESG-related information pertaining to an investee company will be increasingly likely to satisfy the reasonable investor test (and thereby constitute inside information). In practice, this might ultimately ‘translate’ into a working presumption that this type of information will now, on balance, be adjudged to be inside. This approach can be supported by reference to the increasing (and various) ESG-related corporate disclosure requirements now being mandated by regulatory authorities.
[1] Assuming that this phrase is interpreted as “profit at all costs”, regardless of any sustainability considerations.
[2] It is precise and non-public — so only the significant price effect / reasonable investor test remains to be considered.
[i] Whether on account of CSR factors contained in stewardship policies or otherwise.
[ii] As from the beginning of 2021.
[iii] Article 7(4) MAR.
[iv] Article 17 MAR.
[v] Articles 8 and 10 MAR.