The Law Commission report follows the Kay Review and presents its views on how fiduciary duties apply to financial markets. It also clarifies how far those who invest on behalf of others may take account of factors such as social and environmental impact and ethical standards and the question of long-term investment, with reference to pensions where liabilities extend over a long period. The report reaches four main conclusions.

Trustees can only fulfil their fiduciary duties if they take into account all factors they deem important to beneficiary interests, over the time horizons that matter to beneficiaries. As a result, long-term risks, sometimes called environmental, social and governance (ESG) risks, should be included in investment decision making – where trustees believe these factors will affect value over the relevant timeframe. 

Trustees may consider other factors, such as ethical matters, if they believe beneficiaries care about an issue and share a perspective on it, and if doing so will not have a significant detrimental effect on investment returns.

The independent governance committees (IGCs) established by contractual defined contribution (DC) pension providers need to be independent of the providers that appoint them. The Commission believes they must have fiduciary-like duties, in effect making IGC members trustees in all but name.

Other intermediaries in the investment chain are unlikely to be deemed by the courts to be fiduciaries. Instead, the Commission believes that contractual and regulatory obligations will take precedence. 

From the NAPF’s perspective, many pension fund trustees have had a grasp of their fiduciary duties but the report provides reassurance that trustees should use their judgement on what factors are relevant to investment decisions. 

In many cases, trustees will decide this encompasses risks that affect value over the long-term, including issues such as governance and environmental matters. Good trustees are already considering long-term risk factors in their investment approach, so we may see little change in  behaviour, but it may mark the end of the advice sometimes given to trustees that they cannot consider matters such as ESG issues. 

In any case, it is a step away from the most conservative understandings of the Cowan v Scargill legal case of the 1980s, where the judgement has sometimes been understood to prevent trustees from considering anything other than the short-term financial wellbeing of beneficiaries. The Law Commission makes clear that this is a misunderstanding and that factors affecting value over the long term should be taken into consideration.

The report makes a clear distinction between ethical issues and long-term risks that will affect returns. The Commission says trustees are not barred from taking ethical issues into account. It does, however, suggest that trustees should only do so if the beneficiaries share the trustees’ concern about the issue and if taking these factors into account does not have a clearly detrimental financial impact. 

The inclusion of the requirement that beneficiaries share the concern means, in practice, that only trustees of charitable, religious or otherwise clearly ethically-driven funds will feel empowered to take account of such issues in investment decisions. The prospect of mainstream funds polling their members seems unlikely.

The report presses for clearer duties to be applied to the individual members of IGCs to ensure members’ interests are protected. 

One area in the report that drew interest was the debate around fiduciary duties as they apply to intermediaries. The Law Commission has published a brief guide that clearly downplays the role of fiduciary duty in intermediary relationships and instead places the focus on contractual, or regulatory, arrangements.

The Kay Review asserted that fiduciary duties do apply across the investment chain and that these duties should trump contract and exert more influence than regulation. So this approach comes as a surprise.

The regulatory framework for these relationships, and how this might be enhanced to encourage better behaviour and accountability, forms the focus of the report. But, the Commission also considers the contracts between asset owners and their service providers. 

This will not have gone unnoticed by the investment management community, particularly those who market themselves as fiduciaries. If the government takes the Commission’s advice, investment managers working for trust-based schemes will only face a fiduciary obligation where their contract explicitly requires it. 

We anticipate that this will lead to a reassessment of the contractual mandates between pension schemes and investment managers to ensure that members’ best interests are properly considered throughout the investment chain. Over the next few months, the NAPF will be looking at this, reviewing current contracts and suggesting ways to improve practice and increase accountability. 

Where investment consultants are concerned, it seems the Commission’s focus on contract and regulation has tied itself in knots. The Commission’s focus is on regulation as the best way to engender the right behaviour from consultants and its view seems to be that it is anomalous that consultants are not already regulated. However, MiFID, which excludes regulation of ‘generic advice’ – the definition of which covers practically everything provided by most investment consultants, something many trustees may find ironic – appears to limit the reach of the Commission’s own recommendation. 

While the Commission does not call for immediate regulation, it does indicate that investment consultants may need to be regulated. The government is urged to pay attention to this area and consider how to progress it. The sub-text of the report is to find a way to regulate consultants who wield a great deal of influence – an NAPF survey earlier this year showed the top six consultancies account for around 70% of schemes. 

The Commission has invited the Pensions Regulator and the government to reflect these into codes, standards and investment regulations. The Department of Business is due to comment on this and other aspects of the work arising from the Kay Review in the autumn. We look forward to continuing our dialogue with all parties and assisting trustees to understand the Commissions conclusions and its implications.

Paul Lee is head of investment affairs for the National Association of Pension Funds