Law Commission Consults on Fiduciary Duties of Investment Intermediaries

Introduction

On 22 October 2013, the Law Commission published a consultation paper on the fiduciary duties of investment intermediaries. BIS and the DWP had asked the Law Commission to investigate how the law of fiduciary duties applies to investment intermediaries and to evaluate whether the law works in the interests of end investors. The Law Commission chose the pensions landscape in which to conduct its investigations.

In this Alert:

Key points
Fiduciary duties – Trustee duty to invest in ‘best interests’
Considerations when making investment decisions
Workplace DC pension schemes
The rest of the investment chain
Next steps

Key points

The Law Commission does not consider any overhaul to the current law of fiduciary duties to be required.
A trustee’s core duty is to promote the purpose for which the trust was created, which in the case of a pension scheme is the duty to provide pensions.
Trustees may take into account environmental, social and governance factors when making investment decisions but should only take ethical factors into account where members will share the moral view point and it will not result in lower returns.
An industry structure and regulatory framework is required to encourage independent review of investment strategies in workplace DC pension schemes.
The law is uncertain as to the duties placed on non-trustee members of the investment chain.

Fiduciary duties – Trustee duty to invest in ‘best interests’

Although the Law Commission recognises that the law of fiduciary duties is complex and derives from multiple sources, it does not consider that any overhauls to the current position are required.

The consultation summarises the legal duties on pension trustees when considering an investment strategy to be:

The trustee’s core duty is to promote the purpose for which the trust was created, which in the case of a pension scheme is the duty to provide pensions;
Trustees must act within the confines of the legislation;
Trustees must exercise their own discretion;
In reaching their decision, trustees are subject to procedural duties such as a duty not to fetter their discretion, to take advice and to consider relevant circumstances; and
There is an overriding duty to act “with such care and skill as is reasonable in the circumstances”, judged at the time the decision was made.

Considerations when making investment decisions

Environmental, Social and Governance (ESG) Factors

The Law Commission confirmed that trustees may take wider factors relevant to long-term investment performance, such as ESG factors, into account when making investment decisions.

Stewardship

The Law Commission does not consider there to be a general legal duty on pension trustees to engage in stewardship of companies in which they hold shares (eg exercising their influence, entering into dialogue with them or exercising voting rights).

Non-financial factors (eg ethical factors)

The Law Commission’s view of the current law is that ethical issues, unrelated to risks, returns or the interests of beneficiaries, may only be taken into account in limited circumstances. Generally, trustees should only take them into account where they have a good reason to think members will share the moral viewpoint and where they will not result in lower returns for the scheme. Two exceptions are:

Where the scheme is established by a charity or political organisation, the trustees are not required to make investments that conflict with the aims of that organisation; and
Where DC schemes allow members access to ethical funds that may provide lower returns, provided the member has given informed consent.

Workplace DC pension schemes

The Law Commission felt that legal duties are insufficient on their own to ensure good outcomes for members of workplace DC pension schemes, and that those duties need to be embedded in an industry structure and regulatory framework which reinforces and encourages independent review of investment strategies. The Commission defers to the DWP’s programme in this area and the proposed establishment of governance bodies.

The rest of the investment chain

The Law Commission recognises that, although there are clear fiduciary duties on trustees, the duties on other participants in the investment chain are uncertain. In looking at whether such participants owe a duty to their clients or beneficiaries, the Commission concludes:

The Courts look at the contract first and interpret the parties’ duties to each other in line with that contract.
The Courts are highly influenced by the regulatory regime and are reluctant to go beyond the rules set by Parliament and regulators.
The Courts are cautious about finding that those in the investment chain owe duties to others outside the immediate contractual or trust based relationship.