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Law Commission clarifies fiduciary investment duties

01 July 2014

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Pension fund trustees should only take ethical or environmental, social or governance (ESG) issues into account if they are "financially material" to the performance of an investment, the Law Commission has said.

According to the Law Commission's report on clarifying the fiduciary duties of investment intermediaries, trustees do not have to "maximise returns" in the short-term at the expense of risks over the longer term.

The independent body also said that while the pursuit of financial return should be the "prominent concern" of trustees, the law permits trustees to make investment decisions that are based on non-financial factors.

But this is the case as long as trustees have a "good reason" to believe that scheme members share the concern, and that there is no risk of "significant financial detriment" to the fund.

The National Association of Pension Funds (NAPF) head of investment affairs Paul Lee said: "We welcome the clarity and certainty which the Law Commission's work brings to the area of fiduciary duty.

"While many pension fund trustees have always had a good grasp of their fiduciary duties to act in scheme members' broad interests, it is extremely helpful to have the reassurance that trustees should indeed use their judgement as to what is in the beneficiaries' interests over the appropriate time horizon."

Lee added: "In addition, the Law Commission's report brings some welcome clarity to the debate concerning fiduciary duties as it applies to intermediaries.

"As the ultimate decision makers in appointing contract-based workplace pension schemes providers, employers have a responsibility to put in place pension arrangements that offer value for money and act in the scheme members' best interests."

The Commission's report follows on from the Kay Review into UK equity markets and long-term decision making.

Lee said: "The Law Commission does not agree with John Kay, whose review suggested that fiduciary duty should not be varied by contractual terms.

"If the Government takes the Commission's advice, this means that investment managers working for trust-based schemes will only face a fiduciary obligation to the extent that their contract explicitly requires it.

"The NAPF anticipates that over time this will lead to a significant reassessment of the contractual mandates between pension schemes and investment managers to ensure that members' best interests are properly held in mind throughout the investment chain."

The report also examined contract-based pensions, which do not have trustees, and the extent to which contract-based pension providers are under a duty to act in the best interests of members.

Regarding the introduction of a charge cap for default funds in schemes used for auto-enrolment in April 2015, which will not apply to transaction costs, the Commission said there was a possibility that it may create "inappropriate incentives to trade".

The Commission said that as part of the Government's review, it should specifically consider whether the design of the cap has incentivised trading over long-term investment.

First published 01.07.2014