Natasha Browne looks at the findings of the Law Commission's investigation into fiduciary duty in the investment chain
The Law Commission report Fiduciary Duties of Investment Intermediaries, published on Tuesday, looks at how pension funds should balance short-term share price movements against long-term investment decisions. It follows the Kay Review, which raised concern that chasing immediate results was compromising sustainability.
The report says trustees should prioritise investing for "realistic" returns over the long-term rather than trying to maximise short-term returns. It also warned that trustees are confused about what they should take into account when making investment decisions and whether the best short-terms returns should be their main objective.
Law commissioner for commercial and common law David Hertzell said: "There is mounting evidence that companies which treat their customers and suppliers well do better in the long-term. The law does not prevent trustees from taking a long-term view when setting investment strategies."
According to the report, there is scope for trustees to take ethical and environmental, social and governance (ESG) issues into account where it is "financially material" to the scheme. However, it warned that trustees need to differentiate between financial and non-financial factors and apply these to their decisions accordingly.
Law Commission team leader Tamara Goriely made this point at the annual conference of the Association of Member-Nominated Trustees (AMNT) last week (PP Online, 26 June). She said: "Non-financial factors are not to do with the returns for risk but to do with members' quality of life or showing disapproval of unethical activity.
"You can take non-financial factors into account but you have to have a reasonable belief that the issues matter to members. Trustees must not impose their own views on beneficiaries."
Goriely highlighted the importance for trustees to ask the right questions, go through the right processes and get the right advice before acting, which was more significant to the courts than the final decision made by trustees.
Although the financial return should be the main objective for trustees, the Law Commission said the law was flexible enough to allow less important factors to be taken into account. However, trustees need to have a good reason to believe scheme members share their concerns, and that there is no risk of "significant financial detriment" involved in applying those factors.
Goriely said: "The financial circumstances are the default regime when there is significant disagreement. If there is no risk of detriment you probably don't need a strong consensus."
The report also looked at contract-based schemes and welcomed the government's decision to ensure independent governance committees have a duty to act in the best interest of members. It said this duty should not be excludable by contract.
It also pointed to the recommendation that pension providers should be required to indemnify members of their independent governance committees for any liabilities they incur in the course of their duties.
Hertzell said: "We are convinced that by accepting our recommendation to indemnify committee members, the government has paved the way for the best and most skilled to join these important boards."
The National Association of Pensions Funds (NAPF) welcomed "the clarity and certainty" the report brought to the area of fiduciary duty.
Head of investment affairs Paul Lee said: "While many pension funds have always had a good grasp of their fiduciary duties to act in scheme members' broad interests, it is extremely helpful to have the reassurance that trustees should indeed use their judgement as to what is in the beneficiaries' interests over the appropriate time horizon.
"In many cases, trustees will decide that this will encompass risks that will go to value over the long-run, including issues such as governance and environmental matters."
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