Has the Law Commission's fiduciary duty review been successful?
Two years have passed since the Law Commission's landmark review that attempted to clear up confusion over trustees' fiduciary duties. Stephanie Baxter finds despite some initial progress there is much more work to be done.
At a glance
- Review has helped focus trustees' minds but it is just the start of a very long journey
- Managers and consultants urged to do more to help trustees take account of long-term financial risks like climate change
It has been two years since the Law Commission revealed the findings of its major review into the fiduciary duties of investment intermediaries.
Its conclusion in July 2014 that trustees should take into account environmental, social and governance (ESG) factors that are financially material to investment performance was a big step forward. Trustees can also consider non-financial factors including ESG in investment decisions but only if most members agree and it does not give rise to significant financial detriment.
The clarification cleared up some of the misunderstandings over trustees' responsibilities in this area.
Two years on
The degree of progress made was discussed at the Clarifying legal duties: the implications for pensions and climate risk event held by Sackers on 5 July.
David Hertzell, former law commissioner for commercial and common law who led the review, said despite some initial headway there was much more to do.
It found a huge imbalance between the buy-side (pension funds), which is very fragmented, and the sell-side (asset managers and consultants), which is more consolidated. This hinders the ability of buyers to influence long-term investment decisions, he said.
Hertzell welcomed moves by The Pensions Regulator (TPR) to include the commission's advice on its website and in the Trustee Toolkit but said:
"Defined benefit (DB) pension schemes are a cottage industry and trustees will continue to rely on advice they receive from investment managers for better or worse. I would be surprised if many trustees of small schemes were well aware of our recommendations in any great detail or at least felt in a position to do much about them."
However, Association of Member-Nominated Trustees (AMNT) co-chairperson Janice Turner said surveys of its members indicate trustees are concerned about the financial risks posed by climate change. She believes the commission's report "changed everything" as it gave some clarification on what trustees could take account of.
The commission had recommended amending the law to clarify trustees' duties to consider systemic, long-term risks like climate change, and to clarify the difference between financial and non-financial factors.
However, the Department for Work and Pensions (DWP) rejected this, partly on the basis that it would not lead to greater clarity for trustees. The pensions minister said at the event it was better to have guidance and that "government should not step in with a prescriptive approach".
However, Hertzell called this a missed opportunity, warning there is "still confusion and given it's voluntary I'm not sure it will change the status quo".
"It's disappointing the government didn't amend the investment regulations as that would have had impact by focusing minds more. Now we're left with regulations using outdated terminology," he said.
This view was echoed by ShareAction chief executive Catherine Howarth, who heavily lobbied for the regulatory changes. But she said there is still a chance DWP could review its decision to clear up the confusion.
Still resistance
It is important to look at what is happening all the way along the investment intermediary chain.
Turner said despite some improvement, schemes in pooled funds are still being told fund managers are reluctant to include schemes' responsible investment (RI) policies, citing difficulties in managing this.
"This is a huge issue - is it really the case asset owners should have no say in investment policies given half of UK AuM is in pooled funds?"
This led AMNT to introduce Red Line Voting last year, an initiative that aims to help trustees adopt an RI policy and is designed to be easy to use in pooled funds. Although this has been working generally, the AMNT has had some reports of managers resisting.
"The Law Commission's report will only mean more schemes will develop RI policies, and managers need to accept and adapt to it," she said.
Everybody needs to do a lot more: "We need assistance from fund managers who need to sort out voting in pooled funds once and for all, and the Financial Reporting Council should be encouraging that. Investment consultants need to raise RI with schemes to ascertain whether they consider ESG is financial detriment and then develop policies."
Speaking separately, Brighton Rock head of research Con Keating says one of the issues is the commission did not consider the relationship between trustees and managers, and the use of contracts for the provision of fund management services rather than fiduciary. "It's incredibly easy to contract around fiduciary obligations."
Worryingly, in a recent AMNT poll of 12 schemes, 75% said investment consultants have never put RI on the agenda. Turner said the AMNT will conduct a wider survey of its members to see if this is a broader problem.
Keating gives some insight into why this may be the case: "The current value of climate change consultancy is not high enough. A few consultants will do it at the edge - it's just another add-on service for extra fees."
Although MNTs seem to have woken up to the financial risks posed by climate change, this does not necessarily mean all trustee boards have taken heed.
"MNTs are a minority on trustee boards so even though they may be fully committed to Red Line Voting for example, their ability to be able to deliver on that situation is limited," he explains.
"There are circumstances where MNTs will simply be outnumbered. That's one of the real problems this industry has, and is one of the reasons for the imbalance between fund manager power and negotiation and pension schemes."
Is the current regime a barrier to the consideration of financially material issues like climate risk, and is more regulation the answer?
Keating doubts it would make a big difference: "Here we have a world in which moral suasion has failed to deliver the results we believe are appropriate. Everyone's calling for more regulation but is coercion through regulation sound public policy? It will be followed to the letter and spirit by those who are already converted while others will just work their way around it."
There are clearly no easy solutions and the Law Commission's report is just the start of a wider journey towards schemes taking account of long-term systemic risks such as climate change. This must be an ongoing collective effort between trustees and their fund managers and consultants.
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