The Law Commission has been asked to review the legal obligations that arise from fiduciary duties upon parties who invest other parties' money, including pension scheme trustees and investment managers. In particular, what considerations are appropriate for such trustees and managers seeking to act in the best interests of their ultimate beneficiaries? The Commission expects to consult on the issues by October 2013 and provide its recommendations to Government by June 2014.
The investigation is a response to the Kay Report on UK Equity Markets and Long Term Decision Making. The Kay Report identified (among other things) concern about how fiduciary duties are interpreted in the context of investment. A key worry highlighted by the report is that some investment intermediaries are interpreting their duties to their clients or beneficiaries too narrowly to mean a duty to maximise short-term financial returns.
The Commission is investigating what fiduciary duties permit or require these investment intermediaries to consider when developing or discharging an investment strategy. For example, whether they may or must consider:
- factors relevant to long-term investment performance, such as environmental and social impact;
- interests beyond the maximisation of financial return; and
- ethical views of the beneficiaries even if they are not in their immediate financial interests.
What does this mean for pension scheme trustees?
The current law is well developed on the fiduciary duties owed by pension scheme trustees to the beneficiaries or members of the scheme. Pension scheme trustees must act in the best interests of the scheme members which is generally interpreted by the courts to be their best financial interests. The best financial interests will usually mean investing after consideration of the duration of the scheme's liabilities and the risks of the investments, rather than simply maximising short-term financial returns.
It is less clear whether trustees should consider other additional factors and issues when investing, such as the ethical, environmental and social impact. However, a view appears to be developing that the adoption of such considerations by an investment target is likely to be part of a focus upon good corporate governance which, in turn, will impact positively on its business performance, thereby increasing the value of the pension scheme’s investment.
We fully expect the Commission to prohibit or restrict short-termism although the more testing question will be how this is to be achieved or measured. Further, we anticipate two other interesting points to emerge from the Commission. First, the extent to which investment managers and other investment intermediaries appointed by scheme trustees are themselves under a direct or quasi-fiduciary duty when providing their advice and service. Second, the Commission’s interpretation of how trustees and managers should have regard to, and measure, ethical, social and environmental factors within the context of financial return.
The fiduciary duties of pension scheme trustees to their members are reasonably clear, even if they are not always adhered to. Short-term gain has long ceased to be an issue for well-run pension schemes where trustees not only invest with a view to long-term liabilities, often at the cost of short-term gain, but also with a view to limiting the risks associated with pension provision. Furthermore, managers appointed by such trustees will be given strict mandates, as part of an overall strategy, within which to operate. However, this is not a universal practice of all schemes.
The position of investment intermediaries is less certain. Often managers will be provided with a discretionary mandate and the question is whether the manager is free to invest as it wishes in the pursuit of gain or should, acting in their clients' best interests, take into account the long-term goals and objectives of those clients, even if the clients do not recognise them. Even within a structured investment portfolio, managers will have discretion as to how to invest within a particular asset class and against target returns and, again, should those managers take account of the long-term interests of the underlying beneficiaries?
The additional social or moral considerations are more difficult to rationalise. If such considerations lead to investment targets having stronger and more sustainable business models, the principle makes eminent sense as those models may succeed in the longer term over other models which ignore these issues. One senses that this is a correct conclusion but finding empirical evidence of the linkage may be more difficult. However, extending this principle further to allow investment to take account of other worthy considerations which do not impact financial performance may be more difficult to justify. The problem is knowing where, and when, to draw the line. Hopefully the Commission will provide some practical guidance.