The Kay Report: What is meant by 'fiduciary duty'?
The concept of fiduciary duty must be properly understood if trust in the sector is to be restored, says FairPensions' Christine Berry.
Restoring trust was a central theme of the Kay Report, published on Monday. Kay's diagnosis is that equity markets have become dominated by relationships based on trading and transactions, rather than relationships based on trust and confidence. An important part of his prescription is the application of fiduciary standards - the obligations that govern relationships of trust and confidence - throughout the investment chain.
As Kay notes, the erosion of trust in finance is "not a result of misplaced public perception, which can be addressed by a public relations campaign - it is based on observation of what has happened". It's all too easy for the pensions industry to dismiss concerns about trust, blaming them on the public's inability to distinguish between the bankers they love to hate and the people managing their investments. But to apply this logic to the Kay Report's recommendations would be a mistake. Indeed, trust is fast becoming an issue the industry cannot afford to ignore. In the most recent NAPF survey, mistrust of the finance sector overtook affordability concerns as the number one reason people gave for planning to opt out of auto-enrolment.
One common refrain in response to such findings is to insist that we must stop 'talking down' pensions - that airing concerns about poor governance or high fees amounts to an irresponsible fuelling of public mistrust. But such complacency is no longer good enough. As Kay rightly argues, loss of trust will not be addressed by ignoring or playing down the system's deficiencies: it can only truly be addressed by fixing them. The industry has to be both well governed and seen to be well governed. The acceptance of fiduciary standards of care is a good start.
As Kay points out, fiduciary standards are by no means incompatible with commercial agents deriving a profit from reasonable fees for their services - they are only incompatible with profits derived at the beneficiary's expense or without their consent. Fiduciary law accepts that it can be in beneficiaries' interests to be looked after by well-remunerated professionals: rather, it is concerned to prevent situations where the interests of agents directly conflict with those of beneficiaries. If there is a backlash against Kay's proposals, people will rightly ask what the industry has to fear.
If Kay is right to conclude that fiduciary duty, properly understood, is part of the solution, he is also right to acknowledge that, improperly understood, it has too often been part of the problem. As FairPensions has long argued, the reductive mantra of a 'duty to maximise return' has contributed to the fixation with quarterly results and short-term share price movements at the expense of factors affecting long-term business success - including environmental and social risks.
As Kay rightly points out, blaming corporate short-termism solely on insufficient shareholder engagement is not plausible: the problem has just as often been the wrong sort of engagement, as shareholders have been active cheerleaders for risky short-term strategies. Moreover, it's far from clear that institutional investors have been the long-termist anchor they ought to be when companies are buffeted by shareholder demands for short-term return. Narrow interpretations of fiduciary duty must take their share of the blame for this. It's no coincidence that the Co-operative Asset Management, a firm with impeccable ESG credentials and an enlightened approach to its responsibilities, appears to have been the only major asset manager to vote against RBS' takeover of ABN-AMRO.
In this way, narrow interpretations of the law risk damaging the very interests that fiduciary duties exist to protect. As the Kay Report concludes, "there is a need to clarify how these duties should be applied in the context of investment" to ensure that misinterpretations of the law do not stifle the growth of a stewardship culture. This imperative becomes even more urgent if fiduciary standards are to be applied to a new set of actors.
Taken as a whole, Kay's package on fiduciary duty does have the potential to change the way equity markets work. The investment industry would do well to embrace it.
Christine Berry is head of policy and research at FairPensions