Law Commission clarifies law on pension trust investment
Pension fund trustees do not have to “maximise returns” in the short-term at the expense of risks over the longer term, according to a report published today by the Law Commission.
The Government asked the Law Commission to write this report due to concerns raised in the 2012 Kay Review that uncertainty about their legal duties leads investors to focus on short-term movements in share price rather than making long-term investment decisions based on the fundamental value of a company.
Pension trustees should invest to secure the best realistic return over the long-term. But there is confusion over what they are permitted to take into account when making investment decisions and whether they must always be driven by the need to maximise short-term returns.
The Commission's report examines the investment market through the lens of the pensions industry. It evaluates the multiple sources of law that govern pension trustees and the financial markets.
It asks whether trustees of trust-based pensions can make investment decisions motivated by non-financial concerns, such as improving members' quality of life or showing disapproval of certain industries. It also asks whether they can make investment decisions based on environmental, social and governance (ESG) issues that can have implications for the performance of an investment.
The Commission concludes that trustees should take into account factors which are financially material to the performance of an investment. Where trustees think ethical or ESG issues are financially material they should take them into account.
The Commission also concludes that, whilst the pursuit of a financial return should be the predominant concern of pension trustees, the law is sufficiently flexible to allow other, subordinate, concerns to be taken into account. The law permits trustees to make investment decisions that are based on non-financial factors, provided that:
- they have good reason to think that scheme members share the concern, and
- there is no risk of significant financial detriment to the scheme.
The report sets out guidance for pension trustees on their legal duties, and recommends that in the long-term the Pension Regulator endorse the guidance through one of its codes of practice.
The report also examines contract-based pensions, which do not have trustees, and the extent to which providers are under a duty to act in the best interests of members.
From April 2015, contract-based pension providers will be required to establish an independent governance committee to assess their scheme's value for money and quality standards. The Government has already accepted the Commission's recommendations that these committees should have a duty to act in the best interests of scheme members and be indemnified by pension providers for any liabilities they may incur. The Commission's report sets out and refines these recommendations.
The independent governance committee's duty to monitor transaction costs will be reviewed in the Government's planned 2017 review of the default fund charge cap. The Kay Review proposed that investors should be incentivised to make long-term investments. The Commission is recommending that the 2017 review should specifically consider whether the Government's planned cap on fund management charges encourages investment managers to choose short-term trading over long-term investments, and if so, what can be done to address this. The Commission is also recommending a statutory duty on independent governance committees to act with reasonable care and skill in members' interests.
David Hertzell, Law Commissioner for commercial and common law, said:
“There is mounting evidence that companies which treat their customers and suppliers well do better in the long-term. The law does not prevent trustees from taking a long-term view when setting investment strategies. They are free to take account of environmental, social and governance issues or ethical factors where they are financially material, or where the tests we have set out are satisfied.
“There are clear issues with governance in both trust-based and contract-based pensions. We very much welcome the decision to embed independent governance committees within contract-based pension providers. And we welcome the Government's acceptance of our recommendation that these committees have a duty to act in the interests of scheme members. Theirs will be a challenging and complex role. We are convinced that, by accepting our recommendation to indemnify committee members, the Government has paved the way for the best and most skilled to join these important boards.”
The report, Fiduciary Duties of Investment Intermediaries, is available here.
1. The Law Commission is a non-political independent body, set up by Parliament in 1965 to keep all the law of England and Wales under review, and to recommend reform where it is needed.
2. The Kay Review of UK Equity Markets and Long-Term Decision Making: Final Report is available here
3. For more details on this project, click here