Fiduciary duties of trustees and others

Introduction

On 1 July 2014, the Law Commission published its report on the Fiduciary Duties of Investment Intermediaries.

Following the publication of the Kay Review of equity markets, BIS and the DWP 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.

Key points

The Law Commission has concluded that legislation is not required to codify the law in relation to fiduciary duties as they apply to pension fund trustees.
But it has published guidance for trustees which it recommends is included in one of TPR’s codes of practice for trust-based schemes (and is adopted by the FCA in relation to contract-based schemes).
The Law Commission’s guidance sets out its conclusions on trustee fiduciary duties in relation to the exercise of their investment powers, drawing a distinction between financial and non-financial factors.
The Law Commission has also recommended a number of changes to the Occupational Pension Schemes (Investment) Regulations 2005.
When the Government reviews the default charge cap in April 2017, the Law Commission also recommends that specific consideration be given to whether the design of the cap has incentivised trading over long-term investment and, if so, what measures can be taken to reduce this effect.
The Law Commission makes a number of recommendations in relation to DC workplace schemes and also in relation to other participants / duties in the investment chain.

The Law Commission’s conclusions

The Law Commission concludes that, in pensions, the purpose of the investment power is usually to provide a pension. Therefore, the primary aim of the investment strategy is “to secure the best realistic return over the long-term, given the need to control for risks”.

In their Report, the Law Commission draws a key distinction between financial and non-financial factors when considering what can or should be taken into account when exercising investment powers. Financial factors are any factors which are relevant to a trustee’s primary investment duty of balancing returns against risks. A non-financial factor is one motivated by other concerns, such as improving members’ quality of life or showing disapproval of certain industries.

Guidance on fiduciary duties

The Law Commission has set out guidance for trustees to accompany the Report on the extent to which financial and non-financial factors may or should be taken into account. The Law Commission has recommended that TPR considers how the guidance can be given greater authority and exposure, suggesting that initially it may form part of the trustee toolkit but, in the longer term, that it be included in one of TPR’s codes of practice.

In the guidance, the Law Commission makes the following key findings:

The key distinction is between financial and non-financial factors.
Trustees may always take account of financial factors.
Financial factors include any financial factor which is relevant to the performance of an investment, including risks to the company’s long-term sustainability, such as environmental, social or governance factors (ESG factors).
Trustees may not impose their own ethical views on their beneficiaries. If trustees wish to take account of a non-financial factor, they must have good reason to think that scheme members would share their concern and the decision must not involve a risk of significant financial detriment to the fund.
A more flexible approach is permitted for “affinity groups” (schemes where members share a particular moral or political viewpoint, eg a pension scheme set up by a religious group, other charity or political organisation). Here trustees should still ask the same questions, but the answers may be applied more flexibly.

We would urge all trustees with investment responsibility, such as members of an investment sub-committee, to familiarise themselves with this guidance.

Investment Regulations

The Law Commission sets out three aspects of the Occupational Pension Schemes (Investment Regulations) 2005 which they consider could be usefully reviewed:

Small schemes – the removal of the exemption for schemes with less than 100 members from, for example, the requirement that scheme assets must be invested in the best interests of members and beneficiaries.
ESG factors – the reference to ESG factors should be reviewed to ensure it accurately reflects the distinction between financial factors and non-financial factors.
Stewardship – the Law Commission recommends that the Government should review whether trustees should be required to state their policy (if any) on stewardship (potentially in the scheme’s statement of investment principles). In part, this may have been in response to a large number of respondents to the consultation who took issue with the view originally put forward by the Law Commission that “direct engagement with companies was expensive and may be beyond the resources of all but the largest funds.” Many criticised this statement on the ground that even small funds could undertake stewardship activities if they delegated the work to their investment managers. The Law Commission now accepts that even small and medium funds may play an indirect role in stewarding companies.

DC workplace pensions

As well as recommending that the FCA consider whether IGCs need further guidance in “interpreting the interests of members in default funds”, the Law Commission recommends that:

IGCs embedded within pension providers “owe a statutory duty to scheme members to act, with reasonable care and skill, in members’ interests”. This duty “should not be excludable by contract”
Pension providers should be required to indemnify members of IGCs for any liabilities they incur in the course of their duties
As part of its review of the default fund cap charge in April 2017, the Government “should specifically consider whether the design of the cap has incentivised trading over long-term investment and, if so, what measures can be taken to reduce this effect”.

Duties in 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.
The Law Commission’s view is that the law of fiduciary duties should not be reformed by statute, but that the Government should consider whether FSMA should be extended to allow a private person to sue an investment intermediary for loss.
Having decided against recommending a review into the regulation of investment consultants, the Law Commission nonetheless concludes that the lack of regulation in this area is “anomalous” and it has therefore asked the Government to “actively monitor” this area.
Finally, the Law Commission recommends that stock lending fees be considered alongside the review of the default fund charge cap in April 2017.