The Law Commission has released what has been branded a “common sense” guide for trustees, clarifying their fiduciary duties in respect of responsible investment as well as weighing in on defined contribution scheme governance.
The commission concluded there was scope for schemes to take into account non-financial factors when making investments. It also said independent governance committees, which will be required for contract-based schemes from April 2015, should act with reasonable care and skill in members’ interests.
Commission recommendations
Independent governance committees should have a statutory duty to to act with reasonable care and skill in members’ interests and this duty should not be "excludable by contract".
Pension providers should be required to indemnify members of their independent governance committees for any liabilities they incur.
As part of its 2017 review of the charge cap, the government should consider whether it has incentivised trading over long-term investment.
Stock lending fees should also be considered as part of this review.
Source: Law Commission
Paul Lee, head of investment affairs at the National Association of Pension Funds, said the conclusions on the fiduciary duties of IGCs, fund managers and consultants were surprising, arguing that the commission had clearly concluded the role of trustee with fiduciary-like obligations was important across the entire pensions landscape.
“They are saying that in effect IGCs need to be trustees, they need those fiduciary duties,” Lee said. “That is a really major step and an important one, and can have some significant implications for the way in which IGCs are set up and frankly for the mindset of the individuals on them.”
He said that it was surprising that the commission had concluded fund managers and consultants were not also considered fiduciaries.
The independent review body also warned the exclusion of transaction costs from the defined contribution charge cap could incentivise trading at the expense of savers’ long-term interests, and that the regulation of pensions consultants should be “actively monitored”.
Last year, the commission issued a consultation to clarify trustees’ fiduciary duties and focused on “how far those that invest on behalf of others may take into account factors such as social and environmental impact and ethical standards”.
In its report, issued last week, the body concluded that due to the long-term nature of the liabilities of pensions schemes, trustees do not have to “maximise returns in the short-term at the expense of risks over the long-term”.
The commission stated: “Whilst the pursuit of a financial return should be the predominant concern of pension trustees, the law is sufficiently flexible to allow other, subordinate, concerns to be taken into account.”
Jane Samsworth, partner at law firm Hogan Lovells, said the report was a common sense guide but thinks the changes to trustee behaviour will be relatively limited.
“The Law Commission is saying that trustees must, as we always thought they had to, basically give priority to the best financial interests of the members and they can take other issues into account when appropriate,” she said. “Because sometimes when you are looking at so-called ESG aspects, they have financial implications.”
The report also said trustees may take into account non-financial factors, such as ethical issues, if they meet the following:
• They have good reason to think scheme members share the concern;
• There is no risk of significant financial detriment to the scheme.
Louise Rouse, director of engagement at responsible investment lobby group ShareAction, said: “It won’t be possible for funds to simply say we are not allowed [to take into account ethical issues] because we have a fiduciary duty to maximise return.”
The body clarified that a survey of members was not always required. “In some cases trustees may be able to make assumptions: an example might be activities that contravene international conventions, such as manufacturing cluster bombs,” the commission report stated. “In other cases, it may be necessary to consult members formally.”
The report also recommended there be a division between ESG issues as “financial” factors, and ethical or “non-financial” factors – though the change is expected to need further legislative support.
Rouse said this would mean funds could no longer get away with the common “one-liner” in their rules that says they take into account ESG issues as far as they affect financial performance. If this was to become law, they would have to state their stance on ethical issues as well.
“Some may say we don’t take ethical issues into account at all,” she added. “Some may say we do a survey of members.”
ShareAction is pushing for fresh legislation to codify these changes, as Rouse said it was optimistic to rely on regulators to drive it forward.
