Introduction
The climate crisis is critically fueled by the logic of financial capitalism, which sustains funding for fossil-fuel companies. While scholars have researched the dissemination of neoliberal thought and finance’s role in exacerbating the climate crisis separately, too little is known about the relationship between neoliberal thought and financial capitalism, specifically how neoliberal concepts have influenced laws shaping contemporary climate-related investments. Institutional investors have frequently invoked “prudent-person” legislation to justify their continued involvement in fossil-fuel companies. As the dynamics of the financial sector have played a central part in hampering the reaction to the climate crisis, it is crucial to illuminate the history and entrenched rationales of the legal structuring of financial capitalism. This article investigates this relationship by uncovering the development of, and the historical ideas embedded in, the prudent-person principle (PPP), and by elucidating how neoliberal thought has directly influenced critical climate-related investment decisions through legislation. To substantiate this investigation, it is productive first to sketch the importance of this relationship between finance, neoliberalism, and the climate crisis.
In contemporary market societies, the financial sector exerts significant influence across various societal levels, as testified by the burgeoning literature on financialization and by proposals to characterize contemporary capitalism as “pension fund capitalism” or “asset manager capitalism.”Footnote 1 Concurrently, since large-scale fossil-fuel projects (e.g. mines, rigs, pipelines) are typically not expected to generate profits in the first several years of their existence, fossil-fuel firms are continuously raising investments for new projects and returning revenue to investors.Footnote 2 The close relationship between fossil-fuel production and investors, along with fossil-fuel firms’ campaigns to disseminate misinformation about climate science and delay climate action, has given rise to a global movement calling for investors to divest from (i.e. exclude investments in) fossil-fuel companies, initiated in around 2012 by activist Bill McKibben’s 350.org divestment campaign.Footnote 3 Responding to growing calls for divestment, investors in the US and the EU have frequently argued that divesting from the fossil-fuel sector would breach the PPP—sometimes rendered as the legal requirements for fiduciary duty.Footnote 4 In short, the PPP requires trustees to invest in prudent ways; that is, as this article highlights, in ways that adhere to predominant financial norms and theories. To take one example, since 2014, members of several Danish pension funds have raised resolutions to divest from fossil-fuel firms. However, fund boards and managers have recurrently argued that the EU regulation’s PPP requires them to manage risk by diversifying their investment portfolios—which divestment from the coal, oil, and gas sectors would jeopardize, as energy investments made up large parts of the stock market and up to a third of the corporate-bond market.Footnote 5 Following growing calls for divestment, several studies, activists, and financial actors have discussed the potential and effectiveness of fossil-fuel divestment.Footnote 6 Likewise, the PPP’s role in hampering divestment has sparked debates on whether investments in firms whose business plans blatantly conflict with the Paris Agreement’s goal of limiting global warming to between 1.5 and 2 °C may be considered “prudent.”Footnote 7 This article does not aim to settle these ongoing disputes. Instead, it seeks to illuminate how discussions over the legal prudence of fossil-fuel divestment are haunted by the PPP’s neoliberal history, which contains a tendency to support prevailing market forces over political efforts to enhance societal and environmental concerns—thus contributing to debates on how neoliberal ideas have come to structure financial capitalism.
While several studies have traced and contextualized the development of the predominant ideas in financial theory and their ties to the Chicago school from the 1950s to the 1970s, they generally do not analyze these ideas as neoliberal.Footnote 8 Likewise, whereas scholars have duly stressed that the broad neoliberal regime institutionalized by Margaret Thatcher and Ronald Reagan should not be directly conflated with financialization, they often do not draw attention to the intellectual neoliberal origins of prevailing financial theories.Footnote 9 Moreover, historical studies of neoliberalism tend to focus on the ideas’ development but generally avoid tracing their paths through Friedrich Hayek’s “second-hand dealers in ideas” into shaping actual decision making; nor do they usually focus on the development of finance legislation.Footnote 10 Particularly, a growing number of studies have examined the emergence of “fiduciary duty” and the PPP.Footnote 11 Sabine Montagne and others have shown how the PPP in the US was shaped by two influential financial theories: modern portfolio theory (MPT), advising investors to focus narrowly on diversifying their investments, and the efficient-market hypothesis (EMH), considering the market to be perfectly efficient.Footnote 12 Moreover, scholars have analyzed these principles’ implications for climate-related investments.Footnote 13 Yet several issues remain underexplored: what was the historical context of the PPP’s development? What economic actors, structures, and norms did it bolster? Who were the actors that translated the US’s PPP into EU law, and in what context? And to what extent is investors’ divestment hesitancy in the EU and the US shaped by financial ideas from the Chicago school? In brief, exploring these questions reveals that the historical advancement of the PPP and its intensification of the predominant investment rationales, particularly MPT, have come to extend delays in investors’ fossil-fuel divestment.
The argument is not that the absence of the PPP would avert conflicts between divestment and diversification, nor that divestment in the EU was not hampered by other previous national laws. Instead, the article argues that the PPP’s reinforcement of MPT and dominant financial structures and, in the case of the EU, its increased reporting and risk-management requirements prolonged delays in fossil-fuel divestment. Likewise, while it was never legally judged whether divesting from the fossil-fuel sector would violate the EU’s PPP, the mere possibility that sector divestment could breach the law has hampered divestment.Footnote 14
The investigation starts by contextualizing the PPP’s origin in the UK and the US before the twentieth century. It then examines the development of MPT and the EMH at the University of Chicago from 1952 to 1970. It continues by analyzing the enactment of MPT in, and the expansion of, US prudent-person laws from 1974 to 1994. Next, it analyzes how this US history of neoliberal legislation was later extended through the integration of the PPP and MPT into EU legislation between 1991 and 2009. Although large parts of the PPP’s history in the US have already been examined, the article sheds new light on the actors’ backgrounds and the neoliberal networks and ideas shaping the development of the PPP framework through new sources on the involved actors and novel readings of the original legal and theoretical documents. The PPP’s EU legal history is sparsely covered in the literature; here, the article offers original sources on how neoliberal ideas have come to shape contemporary capitalism legally. Moreover, the article brings this history into the present by briefly exemplifying how the EU’s PPP has influenced Danish pension funds’ fossil-fuel divestment decisions. It concludes with reflections on how the PPP could better consider beneficiaries’ both economic and environmental interests by complementing it with formal democratic ways for beneficiaries to express their interests.
Fiduciary duty and prudent person: preliminary definitions and early history
While the principle that trustees should act prudently sounds reasonable, its current legal support for continued fossil-fuel investments mirrors its history of upholding predominant market structures—with little regard for societal or ethical implications. The concepts of prudent person and fiduciary duty are often used interchangeably in contemporary practice, and their histories are interlinked. It is therefore suitable to begin this investigation by clarifying the distinction between, and the origins of, the concepts of prudent person and fiduciary duty to illuminate the ambiguous emergence of the PPP.
The principle of fiduciary duty is commonly taken to be a trustee’s responsibility to act in the best interest of its beneficiary; a fiduciary is a trustee (fiducia is Latin for “trust”). This definition has left ample room for discussions about what this duty entails more precisely. The fiduciary duty in a specific fiduciary relationship is frequently also legally defined in the US and the EU. Discussions of fiduciary duty, therefore, tend to oscillate between what it ought to be and what the law states it is.Footnote 15 Given the diverse nature of fiduciary relationships, which can include various types of trustee with specialized skills sought by beneficiaries, fiduciary-duty laws can be found in a wide range of areas, including not-for-profit organization law, medical-services law, and pension law. Such fiduciary laws can be traced back to medieval English law, Roman law, and Jewish law, among others.Footnote 16
In comparison to fiduciary duty, the PPP is a newer, more specific, and distinctly juridical principle. In its broadest sense, the PPP requires fiduciaries to undertake their fiduciary tasks as “prudent persons” would. Long dubbed “the prudent-man rule,” it was originally often applied in cases involving widowed beneficiaries, reflecting a legal origin in which “children, lunatics and women” were not presumed prudent.Footnote 17 “Man” was later replaced with “person” and, instead of “rule,” I use the term of the EU’s Solvency II legislation, “principle,” hence PPP.
Although prudent-person decisions were already present in the 1754 British trust law case Belchier v. Parsons, scholars have mainly focused on the PPP’s emergence in the US with the 1830 Massachusetts court decision in Harvard College v. Amory; the latter is also the relevant starting point for understanding its convergence with neoliberal finance thought.Footnote 18 The backdrop of this case is the intertwined story of industrialization in the US, increased global trade, and the colonial world order. While slavery had been abjured in Massachusetts, merchant John McLean had made his fortune through trades based on slave labor, including considerable speculation in molasses. From a business perspective, these activities were somewhat risky, leading to significant fluctuations in his fortune.Footnote 19 McLean had entrusted his wife’s brother and cousin, Francis Amory and Jonathan Amory, with investing McLean’s inheritance as he himself would have done for as long as McLean’s wife remained alive. However, the Amorys’ investments lost money. The court had to decide whether Francis Amory, the surviving trustee, ought to pay restitution to Harvard College and Massachusetts General Hospital, which would have benefited from McLean’s legacy. In the ruling, Justice Samuel Putnam wrote,
All that can be required of a trustee to invest, is, that he shall conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.Footnote 20
The verdict stated that Amory had indeed invested as prudent persons would be expected to. Implicitly, this ruling labeled McLean’s activities as “prudent,” and explicitly it judged the risky contemporary business and investment practices as prudent. McLean’s business and slavery activities add a previously overlooked chapter to the literature on the PPP’s history and supplement the history of finance with yet another example of how finance has served to support the exploitation and exclusion of the poor and marginalized.Footnote 21 While the 1830 ruling established the PPP as a legal precedent, it would still take many years for the PPP to acquire its current shape and climate-related impact.
The Chicago school and finance theory
Until 1939, the PPP established in Harvard College v. Amory had spread only slowly from Massachusetts to eight other US states. In the wake of, among other things, the Great Depression and opposition to the New Deal, a reform movement of bankers and lawyers emerged that promoted professional investment management through the PPP. This contributed to its adoption in all but twelve states by 1953, illustrating how foundations for large-scale financialization were already being laid.Footnote 22 The PPP replaced a system in which legislators confined trustees to limited lists of allowed investments. It thus created more flexibility for investors while, as illustrated, boosting prevailing norms for sound investment decisions. However, both these norms and the actual definition of the PPP would later be changed to align with financial ideas developed at the Chicago school from the 1950s to the 1970s, notably MPT and the EMH—encouraging investor passivity and supporting the industries predominant at any given time. Therefore, to understand the development of the current PPP, its intertwinement with further financialization, and the rationales of these ideas, it is necessary to make a theoretical stop in Chicago.
In 1905, economist Irving Fisher suggested that the value of a stock should be determined on the basis of its projected yield, and that uncertainty should be factored in using probability calculations. In his 1938 work The Theory of Investment Value, John Burr Williams expanded on Fisher’s method of valuing stocks by proposing that stocks should be valued according to their expected future yield and risk. This proposition set the new, influential standard for investment strategy.Footnote 23 In 1952, this approach was challenged by Harry Markowitz, then only a doctoral student at the University of Chicago, who observed that Williams had focused on the risk–return profile of individual stocks but lacked a concept of the risk of the entire portfolio.Footnote 24 Markowitz gleaned this insight from participating in the Cowles Commission, where he stumbled upon a 1933 paper by the commission’s eponymous founder demonstrating that investors had been unable to forecast market movements.Footnote 25 This empirical study also helped pave the way for the EMH.
The proposition that investors generally cannot beat the market inspired Markowitz to rethink investment theory. In 1952, in his paper “Portfolio Selection,” Markowitz argued that instead of focusing on the risk–return profile of each individual stock, as Williams had proposed, investors should focus on the risk–return profile of their combined investment portfolio. Corporations within similar sectors will tend to be affected by the same factors. Thus the returns on these firms have a high covariance.Footnote 26 As investors cannot predict which stock prices will be affected by which future events, Markowitz advised investors to diversify their investment portfolios to include investments in various firms, sectors, and asset classes (e.g. stocks, bonds, real estate). If investors followed this approach, they would still suffer during wide-scale market crises, so-called “systematic risks,” but they would diversify away the individual risks connected to individual investments. The risk–return relationship could now be expressed by a utility curve. The various risk–return utility curves between potential portfolio combinations would make it possible to compare which portfolio combinations had the most efficient risk–return profile: the combination to choose among the best combinations would then depend on the individual investor’s risk–return preferences.Footnote 27 Markowitz basically stuck to this core argument, and in 1959 he substantiated these thoughts in a monograph, helping to further disseminate MPT.Footnote 28 In the 1960s, however, Markowitz’s approach was unusable for actual investors because it required data sets that were too large to handle with the limited capacity and availability of contemporary computers. William Sharpe (among others) made it applicable through a simplified model for calculating portfolio risk, called the capital asset pricing model (CAPM)—which measured a security’s risk in relation to market risk, instead of calculating it from the cross-correlations between each individual stock in the portfolio as Markowitz had proposed.Footnote 29 Today, the principle of risk management by portfolio diversification, known as MPT, predominates in financial theory.Footnote 30
Markowitz’s work simultaneously broke with and expanded the scope of neoliberal thought at Chicago. Markowitz’s work was so unusual that, during his dissertation defense, his co-supervisor, Milton Friedman, questioned whether Markowitz should be awarded a degree in economics because his portfolio theory had more resonance with finance than with economics.Footnote 31 While Markowitz’s approach differed from Friedman’s, it remained a neoliberal framework. For one thing, Markowitz was trained at the University of Chicago under Friedman’s mentorship, which brought him into close contact with the neoliberal thought collective.Footnote 32 Second, and more importantly, his theory of portfolio diversification built on and reinforced the neoliberal postulate that the market’s ability to coordinate economic information was far superior to the conscious decisions made by individuals, be they bureaucratic planners or investors.
To grasp MPT’s influence on present-day investment decisions, it is helpful to understand the theoretical underpinnings of the milieu at the University of Chicago during the postwar era. For the purposes of this article, neoliberalism is non-exhaustively conceptualized as being predicated on two key premises. First, neoliberals consider the price mechanism a system of coordinating information among market actors—this element is bolstered by MPT and the EMH. Second, neoliberals do not necessarily strive to minimize the state, but rather consider the state’s role to be to serve and support the market, notably by establishing and maintaining legal and institutional frameworks—the PPP is an example of such support of the market.Footnote 33 In 1953, Friedman claimed that economics should be positivist, meaning free of normative judgments (apparently expecting this to be possible), and that simplicity and fruitful assumptions should be preferred over complex but more precise assumptions.Footnote 34 Friedman’s argument about fruitful assumptions would help boost the EMH (see below), and his argument about positive economics helped advance his view that “the business of business is business”; that is, that firms should not be concerned with the societal or environmental consequences of their decisions. In 1962, drawing on his reading of Adam Smith’s “invisible hand,” Friedman advanced his argument by reasoning that the market was most efficient when each firm sought to maximize its own profit.Footnote 35 Accordingly, Friedman argued, “Few trends could so thoroughly undermine the very foundations of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible.”Footnote 36 Similarly, for Hayek, the market mechanism was a more efficient way to coordinate information among societal—that is, market—actors than a centrally coordinating state.Footnote 37 As discussed below, these ideas served as a backdrop for the advancement of, and synergies between, MPT and the EMH.
The EMH was proposed by Eugene Fama, a faculty member and also a former student at the University of Chicago, who enrolled in the MBA program in 1960. While Hayek and Friedman’s ideas centered on the corporation and the market and not specifically finance, Fama expanded their ideas about market superiority to the field of finance. In the preceding decades, researchers had discussed whether patterns in stock movements could be identified or whether these movements were mere “random walks.”Footnote 38 Whereas Alfred Cowles III had demonstrated that the stock market average often outperformed individual investors’ forecasts, and whereas Friedman and Hayek had argued that the market was more efficient than state intervention, Fama took the neoliberal perspective to its logical extreme by arguing that the stock market was perfectly efficient—what became known as the efficient-market hypothesis (EMH).Footnote 39 Since the individual actors in the market decided to sell or buy according to their individual knowledge, security prices would “at any time ‘fully reflect’ all available information.”Footnote 40 When analyzing the relationship between individual securities’ returns and general market conditions, Fama relied on the models of Markowitz and, especially, Sharpe.Footnote 41
In short, this article argues that several of the core tenets of financial theory, norms, and law can be conceptualized as neoliberal. Specifically, the combination of the above Chicago ideas, particularly the EMH and MPT, has the following implications for institutional investment decisions. If market prices have already integrated all relevant information, then it is generally impossible to consistently “beat the market.” This reasoning implies that the best strategy for investors is to diversify their portfolios to minimize risk, and if, on average, stock prices grow over the long term (a trend that both neoclassical and neoliberal economics presume), then investors may expect to make at least the average gain in the market. While Fama later admitted that the EMH had several empirical flaws, for example concerning irrational bubbles and anomalies related to factors such as size and value, less attention could be paid to these as long as the hypothesis had a clear and broad explanatory scope, following Friedman’s methodological argument.Footnote 42 Moreover, with cover from Friedman, neither investors nor firms should be concerned with priorities other than profit maximization, given that this is the optimal way to increase the total wealth of society. Finally, if the market is efficient and investors must diversify their investments widely, investors should continue to invest in the entrenched fossil-fuel capital structures—and in an increasingly financialized world, the impetus of the means of finance has a significant impact on the direction of the economic sectors; that is, supporting the status quo.Footnote 43
Merging modern portfolio theory and the prudent-person principle in the US
Following Markowitz’s publications in the 1950s and the subsequent elaborations by fellow members of the Chicago school, MPT’s influence on finance theory, now centered on portfolio risk management, would come to be considered a “revolution” in the investment world.Footnote 44 As noted above, William Sharpe and others helped simplify MPT, and Fama and others expanded its applicability and refined its interpretation through the EMH. Moreover, scholars associated with the Chicago school authored introductions and textbooks disseminating MPT.Footnote 45 This section examines how neoliberals sought to combine and advance MPT and the PPP to bolster the predominant market structures and actors.
The most central event in the codification of MPT and the PPP arguably was the passage of the Employee Retirement Income Security Act (ERISA), a US national pensions bill passed in 1974. The background for the reform was several cases of misconduct plaguing pension funds in the 1960s.Footnote 46 Those in the government who promoted a revision of the pension legislation used these scandals to advance their case. One consequence of highlighting these scandals was that it made it seem preferable to rely on investment professionals who used state-of-the-art financial theories instead of having employees or union representatives determine investment policies.Footnote 47 This preference for investment professionals over representatives paved the way for the integration of the PPP into US national pension law, as preventing misconduct involving fund money was fundamental to the PPP.Footnote 48 This preference also mirrored the PPP’s history of favoring competent trustees over presumably imprudent beneficiaries, such as widows and children. Moreover, whereas in Harvard College v. Amory the PPP referred to “how men of prudence, discretion and intelligence manage their own affairs,” to be a prudent fiduciary was no longer to act as any prudent man would. Instead, it implied acting as prudent investors would. Acting like persons familiar with “such [investment] matters” implied that the fiduciaries should be acquainted with state-of-the-art financial theories. Furthermore, it was explicitly prescribed that fiduciaries should diversify their portfolios.Footnote 49 While the passage of ERISA largely meant integrating portfolio diversification into prudent-person legislation, ERISA did not explicitly reference MPT. If MPT were fully applied, it would mean that riskier investments could be just as good for a portfolio’s total risk–return profile as less risky investments. Following the enactment of ERISA, investors hesitated to invest in new alternative investment products, such as derivatives, fearing that such investments would be deemed imprudent.Footnote 50
The full integration of MPT into the US prudent-person legislation did not arise out of the blue. Finance historians Sabine Montagne and Sean Vanatta have shown that the US prudent-person law has several meanings and origins, including the budding rise of pension funds in the US, the theory and practice of MPT already spreading, and mounting trends in the 1950s and 1960s toward the professionalization of pension investments.Footnote 51 Although it is true that US legal history is multifaceted and contingent, it is instructive to understand and emphasize the distinctive neoliberal influence on PPP legislation; this influence is missing from most accounts of the topic.Footnote 52 Furthermore, while building on Montagne’s analysis, the above story supplements it, in part by adding the role played by a variety of neoliberal actors in disseminating MPT through introductions and textbooks. In part, too (in the following), this study highlights how the integration of MPT into legislation was pushed forward by legal scholars at the Chicago school, notably John Langbein and Richard Posner; whereas Montagne only briefly mentions these actors, this article deems it valuable to elaborate further on their influence.
Posner and Langbein were key actors in furthering the integration of MPT into prudent-person legislation. Posner came to Chicago in 1969 on a fellowship provided by the Law and Economics program, which focused on enhancing the market mechanism through law. Central figures in this program were Aaron Director and Edward Hirsch Levi (also MPS members). In a 1956 article on antitrust legislation, Director and Levi argued that courts should rely less strictly on written laws and more on a “rule of reason,” which would give justices the opportunity to rely less on government-imposed laws, and more on state-of-the-art (i.e. neoliberal) economics—since the latter could purportedly ensure the rule of reason.Footnote 53 Posner further advanced the role of neoliberal economics in the sphere of law in his influential 1973 textbook for lawyers, judges, and policy makers, Economic Analysis of Law. He highlighted how economic analyses can be applied to almost any legal sphere, including “crime control, accident law, contract damages, race relations, judicial administration, corporations and securities regulation, environmental problems, and other areas of central concern in the contemporary legal system,” and argued that the central “meaning of justice, perhaps the most common is—efficiency. [Since] in a world of scarce resources waste should be regarded as immoral.”Footnote 54 This effort to increase the role of neoliberal economics in legal decisions is reinforced by the PPP, since it encourages investors to follow state-of-the-art investment theory; that is, to follow the “rule of reason,” rather than strictly obey other legislative decisions.Footnote 55 It is worth noting that this logic is supported by the common-law system, which, as Katharina Pistor has demonstrated, grants corporate interests greater autonomy from the state in shaping the law compared to civil law.Footnote 56 In an influential 1976 article, described as “a veritable intellectual earthquake … [in the] formulation of prudent person fiduciary standards,” Langbein and Posner argued that trustees’ investment decisions should be evaluated at the portfolio level, in inspiration from the state-of-the-art MPT, rather than the then widespread practice in courts of judging trustees’ investment decisions regarding individual assets.Footnote 57 They argued that prudent-person legislation should ensure the focus on trustees’ combined portfolio performance, which they held would encourage investors to invest passively in the market index.Footnote 58
In the following decades, Langbein, Posner, and their colleagues would advance their position by regularly publishing new texts on prudence legislation, ERISA, and MPT.Footnote 59 The appointments of Posner in 1981 and of Frank H. Easterbrook (a senior lecturer at the University of Chicago) in 1985 to the US Court of Appeals for the Seventh Circuit also increased their ability to advance MPT-informed rulings.Footnote 60 In line with these tendencies, US investment legislation progressively integrated MPT more explicitly. In 1979, the US Labor Department released an interpretive regulation to demonstrate that ERISA did establish opportunities for investments in alternative products, such as derivatives, and specified that the definition of “prudence” should be understood in relation to the whole portfolio—this contributed to the rise of the options market from the 1980s onward.Footnote 61 Arguably, Langbein’s efforts to promote MPT in investment legislation culminated in 1994, when he was appointed a reporter on the mutual-fund regulation the Uniform Prudent Investor Act (UPIA). In this position, he was able to cite his, Posner’s, and Brealey’s MPT texts as the main literature informing the UPIA. The UPIA statute codified MPT’s role in US investment law by describing itself in the actual statute document as “under the influence of a large and broadly accepted body of empirical and theoretical knowledge about the behavior of capital markets, often described as ‘modern portfolio theory.’”Footnote 62 In short, MPT was first implicitly included in the national pension fund prudent-person regulation (ERISA, 1974), then explicitly incorporated into this legislation (1979), and subsequently also inscribed into the mutual-fund regulation, explicitly based on the Chicago scholars discussed above (UPIA, 1994). MPT was now law. MPT no longer merely stated what the best investment strategy was; it was now the legally required investment strategy for fund managers, covering the vast pools of both pension and mutual funds.
Although MPT’s ingress into US investment legislation and the development of the PPP were informed by many different actors, and although the scope of the PPP’s influence on justices’ actual rulings varies, this article argues that Chicago school actors and their finance theories have significantly influenced current US investment legislation in ways that enhance MPT and the market actors predominant at any given time.
Fossil-fuel investments in the EU: how did the prudent-person principle enter EU investment legislation?
Although both MPT and the PPP emerged in the Anglo-American world and common-law tradition, the question pursued now is through which actors these principles entered EU legislation.Footnote 63 As a brief perspective, this section also discusses what consequences this legal trajectory had for continued fossil-fuel investments, exemplified by the case of Danish pension funds’ divestment decisions.
A long-standing ambition of the EC was to align its internal markets. Pierre Alayrac and Laurent Warlouzet note that, in the 1980s and early 1990s, the establishment of an internal market was characterized by negotiations between François Mitterrand’s focus on workers’ rights and Thatcher’s focus on efficiency, deregulation, and market competition.Footnote 64 This process involved aligning the various European pension regulations. In the 1990s, Europe was, in Michel Albert’s description, dominated by investment rules of two types. The “maritime” model encompassed the prudent-person regulations of the UK, Ireland—whose legal history was shaped by British rule—and the Netherlands, with its “solid investment rule.” The “alpine” model denoted the state-centered pension plans of continental Europe.Footnote 65 A discussion of the legal histories of the UK, the Netherlands, and Ireland is beyond the scope of this article; here it suffices to note some instances in which MPT and European PPP legislation altered these countries’ existing national legislation. First, as MPT gained influence in the 1980s, the consensus in the Netherlands on what constituted “solid” investments changed from fixed-income assets to more corporate-equity investments. Moreover, the Dutch “solid investment rule” did not reject social investing as firmly as its US counterpart did.Footnote 66 Second, although the UK had requirements for investment diversification since the Trustee Investments Act of 1961, both Russell Galer and Wiaan van Tonder have argued that the Trustee Investments Act of 1961 failed to implement the principles of MPT (similar to the initial critique in the US that ERISA had not fully integrated the MPT principles), something that was largely remedied by the passage of the UK Trustee Act 2000.Footnote 67 Hence the full UK adoption of MPT only occurred after the MPT and PPP discussions had been taken up in the EC from 1991 onward (as discussed below).
Whereas the alpine model was based both on state-sanctioned quantitative limits for investments in given investment products (similar to the earlier limited-list system in the US) and on a principle of national solidarity, the prudent-person model focused on maximizing individual groups’ pensions through investments and market competition.Footnote 68 Although Warlouzet has argued that less harmonization was often encouraged by neoliberals, as less harmonization meant “less protection for workers, consumers, and the environment,” this article contends that harmonization toward the PPP amplified the marketization of pensions and enhanced the financialization of the EU.Footnote 69 Thus PPP harmonization turned the EU more neoliberal in the sense that the expanded role of private pension schemes extended market logic not only within the pension sector but also across the different societal spheres in which pension funds are invested.
In 1991, Leon Brittan, the commissioner for competition and financial institutions and a former minister in Thatcher’s government, made the first attempt to subject the EC states to the PPP. The UK, Ireland, and the Netherlands accounted for the vast majority of private European pension funds at the time. These funds—particularly through their organization, the European Federation for Retirement Provision (EFRP)—pushed for the adoption of a common PPP in Europe, as this would expand the funds’ investment market in Europe by erasing national quantitative investment restrictions.Footnote 70 Brittan’s attempt failed since the states could not reach an agreement on the PPP. Nevertheless, the EFRP and the financial sector continued to highlight how “the EU could face a huge crisis caused by the increasing burden of an ageing population,” and, as argued by Robert C. Pozen, vice chairman of Fidelity Investments (and member of President George W. Bush’s Commission to Strengthen Social Security), “Raising taxes or cutting benefits would be politically unpopular ways for [the states] to close their financing gaps … [a] more effective step would be to allow European pension-fund managers to freely invest in a diversified portfolio of securities.”Footnote 71 Similar arguments about the mounting “age burden” were significantly solidified and advanced during the 1990s by the World Bank and the Organisation for Economic Co-operation and Development (OECD), and these arguments contributed to a general push in Europe to move from state-sponsored (pay-as-you-go) pensions to investment-reliant occupational pension funds, fostering increased financialization.Footnote 72 In 1997, Mario Monti, the internal-market commissioner, reignited the discussion surrounding an internal market for pension funds within the broader framework of addressing the challenges presented by an aging population.Footnote 73 The director general for the internal market and financial services, John Mogg, steered this effort. Mogg was part of Brittan’s network and, among other things, he led the SLIM (Simpler Legislation for the Internal Market) program, which aimed to deregulate the internal market.Footnote 74
In 1997, in a Green Paper produced under the direction of Mogg, the commission proposed an alignment of the EU’s investment rules and practices through a prudent-person implementation of MPT. At that time, US management techniques had been disseminated to Europe through multinational corporations and “the missionary world of U.S. pension consultants.”Footnote 75 Accordingly, the Green Paper described acting “prudently” as following “modern risk management techniques,” which were those of MPT.Footnote 76 Integrating the PPP would shift risk legislation from being quantitative to being qualitative, although this definition of “qualitative” investment decisions would be confined to the limits of MPT. Although one may find both prudent-person legislation and subfields of national investment legislation that require portfolio diversification pre-dating 1997, this is the first explicit merger of MPT and the PPP in EU and Danish legislation.Footnote 77
In 2003, Monti’s, Mogg’s, and the EFRP’s efforts succeeded when the EU passed Directive 2003/41/EC on institutions for occupational retirement provision, which explicitly integrated the PPP and diversification requirements based on the legislative process initiated with the 1997 Green Paper. It stipulated, “As a general rule, asset allocation must be prudent. This requires, above all, a proper diversification in terms of issuers, types of securities, country/geographical zone, currency and industrial sector.”Footnote 78 In 2009, the commissioner for internal market and services, once dubbed “the most neo-liberal of the 27 commissioners,” Charlie McCreevy, headed the passage of the EU’s Solvency II directive, which further expanded the PPP to also cover life insurance companies, including certain groups of pension funds encompassing Danish funds.Footnote 79 Thus the PPP and MPT’s widespread integration into EU legislation was accomplished.
The EU’s Solvency II directive was developed in the aftermath of the 2007–8 financial crisis, and expanded risk requirements seemed to be an appropriate response to the crisis. Hence Solvency II’s requirements for reporting and risk management were significantly scaled up, so investors could be more easily held accountable if they failed to fulfill their prudent-person duties. Yet the combination of expanded risk control and an increased focus on alignment with state-of-the-art finance theories, in casu, MPT, also made investors more hesitant to divest from fossil fuels, as this would imply diverging from full-sector diversification. At the time of the adoption of the PPP, several member states feared that the PPP could lead to too many risky investments, including derivatives.Footnote 80 This worry did not involve fossil-fuel investments. At most, there is a certain resemblance in the concern that diversification could imply unwanted investments.
The effects of this legislation can fruitfully be illustrated through cases from the Danish divestment debate. This debate has been remarkably intense since members tend to have more direct power over their pension funds’ investment decisions than in most other countries: some pension funds even allow their members to raise and vote on general-assembly resolutions and to elect up to half of the funds’ board members.Footnote 81 Reviewing several cases from this debate, it cannot be established that the EU’s PPP is the direct or sole reason for Danish pension funds not to divest. In the early Danish divestment discussions, references were made to Danish laws that pre-dated the EU’s PPP.Footnote 82 Still, the effects of the EU’s PPP are clearly observable. First, previous Danish legislation focused more broadly on profit maximization; with the adoption of the PPP, a significantly greater emphasis has now been specifically placed on risk monitoring and diversification, which complicates the case for sector divestment.Footnote 83 Moreover, the fact that it has not been tested in court whether fossil-fuel divestment legally complies with the prudent-person legislation has provided yet another argument for abstaining from divestment.Footnote 84 Additionally, the PPP has been given priority over investments aligned with the EU’s taxonomy for green investments.Footnote 85 Furthermore, in several instances, pluralities of members in member-democratic Danish pension funds have voted for divestment in general-assembly resolutions.Footnote 86 Yet when the Danish Financial Supervisory Authority (DFSA), which enforces the EU’s PPP in Denmark, was asked whether collective democratic funds could divest if the members voted for divestment, the DFSA limited its answer to obscurely stating that it would still depend on a concrete judgment of the investment policy that had been “offered in prospect to” (stillet i udsigt) the members, and when the member-democratic pension fund, AkademikerPension, announced large-scale fossil-fuel exclusion criteria, the DFSA issued a formal warning.Footnote 87 Taken together, the PPP has not altogether prevented divestment; rather, these aspects illustrate how it has given institutional investors stronger reasons for divestment hesitancy.Footnote 88
In short, the EU’s integration of the PPP was informed by MPT and pushed forward by other political actors—notably private pension funds and British officials with ties back to Thatcher’s government—who aimed to enhance the single market and the financialization of the EU. Echoing its US trajectory, the legal meaning of “prudent” fortified the logic of the market and was defined according to MPT. Although it was not originally formulated to defend the fossil-fuel industry, its widespread adoption in the North Atlantic has serendipitously bolstered this besieged industry in recent decades.
Remarkably, while the genealogy of the PPP in the US clearly boasts neoliberal parentage, it is far more difficult to trace the direct intervention of neoliberal actors in the concept’s EU history. Instead of MPS members, the PPP relied on “second-hand dealers,” including managers of private pension funds, commission officials, the World Bank, and the OECD, who coupled a looming old-age crisis with a need for pension privatization and expansion of the financial market. MPT has long been a predominant financial theory. Hence financial actors generally would be expected to have been shaped by and to support this theory. MPT’s wide influence, its further expansion, and its co-advancement with the PPP are evident in MPT’s integration into the EU’s PPP.Footnote 89
Limits of and perspectives on the prudent-person principle
The story of the recent clashes between the PPP and demands for fossil-fuel divestment is a story of how the law and neoliberal theories have been advanced to bolster the financial market and its predominant actors. The PPP does allow some investment flexibility and does not specify the exact limits of MPT, and the argument is not that the PPP has determined investors’ climate-related or other investment decisions. Instead, this article argues that the PPP has encouraged a certain investment logic while disincentivizing other approaches. The PPP has repeatedly given priority to the dominant financial actors and investor rationales, and as MPT became influential in the financial world, it came to shape and be reinforced by the PPP. The combination of the PPP with MPT’s demand for diversification and the EMH’s belief in the rational market significantly bolstered passive investments in the market index, hence in the predominant market actors. It is remarkable how the PPP, MPT, and the EMH were pushed forward, disseminated, and legally adopted by a network of neoliberal lawyers and academics. This work paved the way for private pension funds and officials who supported the expansion of the European financial market to integrate a similar version of the PPP, informed by MPT, into European legislation. This dissemination of the PPP and MPT in the US and the EU forms a backdrop to contemporary financial capitalism and the discussions surrounding the legality of fossil-fuel divestment—discussions that provide conservative investors with yet another reason to postpone divestment decisions and passively adhere to the movements of a diversified market index. It should be noted that the present analysis does not dismiss climate organizations’ efforts to argue that acting prudently requires, or should require, investors to take substantial climate measures.Footnote 90 Instead, it shows that climate investment efforts should be aware of how the PPP has been used to support predominant market forces.
The foregoing discussion of how the neoliberal interpretation and propagation of the PPP came to hamper contemporary institutional investors’ divestment decisions points toward a critical discussion regarding institutional investors and trusteeship: how can fiduciaries understand and serve the interests of their beneficiaries? In a conceptual study, Joakim Sandberg argued that the conceptual limits of the fiduciary-duty concept are not suited to encouraging socially responsible investments. Particularly, Sandberg reasoned that “different beneficiaries have different ethical opinions” and that, according to the UN-commissioned “Freshfield report” (and other scholars), “trustees are required to treat beneficiaries even-handedly, and not take sides between different groups.”Footnote 91 Although Sandberg’s argument that absolute consensus among pension fund members cannot be expected is correct, the cases from the Danish pension funds testify to another possible path forward.Footnote 92 Belief in the importance of an absolute measure of what various parties find useful has largely made economists focus narrowly on quantitative utility; that is, on maximizing profits—as advanced by the principle of Pareto efficiency.Footnote 93 This line of thinking implies that members’ interests may be measured only in quantitative terms, since different members will have different, and hence more or less conflicting, qualitative interests. Yet, as indicated by Danish pension members, when members are given the chance to raise and vote for or against general-assembly resolutions, as well as to run and vote for pension fund board members, they have the opportunity to express in a much more nuanced way which concerns they believe should be considered their main interests, and how their various interests should be prioritized.
If the inherent objective of the PPP is to make fiduciaries act in the beneficiaries’ best interests, then it seems appropriate to amend the existing legislation to ensure that members’ formally voiced views receive higher priority. It would still be possible to require fiduciaries overall to strive for risk-adjusted return maximization, using diversification to serve the beneficiaries’ interests. This focus should be subject to the wishes and frameworks defined by the members, but not the reverse; that is, only pursuing the members’ wishes when they align narrowly with MPT. This logic may have even further implications. The cases reviewed above concern only democratic pension funds, not commercial or state-owned pension funds or institutional investors more broadly conceived. Their members generally have no comparable formal ways to express their wishes and concerns, which complicates the possibilities for commercial and state-based funds to make decisions that align with their members’ interests. Therefore, if the purported logic of the PPP is to be strictly realized—if fiduciaries must act in the best interests of the beneficiaries—then institutional investors need to adopt principles that give their members an actual democratic voice, including letting members vote, put forward resolutions at general assemblies, and contest board positions. In short, in a world where investors play an increasingly critical role in exacerbating climate change and in a world where pension members have been shown to prioritize green investments, it is indeed prudent to make institutional investors actually act in the best interests of their beneficiaries.
Acknowledgments
Participating in the development of this forum has greatly advanced both the present article and my academic thinking. I want to deeply thank everyone involved along the way, including Thomas Turnbull, Niklas Olsen, Ben Jackson, and Dieter Plehwe, but most of all Troy Vettese and Isabel Oakes for organizing and steering the whole project and for their detailed and dedicated support throughout the years. Many other generous readers also deserve special mention, including Christian Olaf Christiansen, Kristian Bondo Hansen, Natascha van der Zwan, Mikkel Thorup, Anne Mari Borchert, Linda Soneryd, Leila Brännström, Richard Swedberg, and Dominik Döllinger, among several others.
Financial support
This work has been supported by the Carlsberg Foundation, grant CF25-0471.
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