Strengthening the legal duties on financial professionals to act in the best interests of savers
Today the Law Commission publishes a consultation paper reviewing how “fiduciary duties” apply to investment intermediaries. The paper traces a chain of intermediaries from an individual, saving for a pension, to the registered shareholder of a UK company. It looks at the obligations of those in the chain to act in the interests of savers.
The Commission's project arose out of the Kay Review of the UK equity market. Published in July 2012, the Kay Review criticised intermediaries for excessive trading on the basis of short-term share movements, rather than investing for the long-term.
Trust-based pensions
In trust-based pensions, trustees must act in the interests of savers. The Law Commission sets out its initial view that the law does not prevent trustees from taking a long-term approach. Trustees may take account of environmental, social and governance issues, where these are relevant to risks and financial returns. But trustees should be careful to keep the purpose of the investment in mind, which is to provide a pension for the saver. They should not attempt to make ethically motivated decisions or improve the world in some general sense, possibly at the expense of future pensioners.
David Hertzell, the Law Commissioner leading the project, said:
“There is mounting evidence that sustainable firms that treat their customers and suppliers well do better in the long term. Trustees are entitled to pick stocks on the basis of these factors, when they think that this will improve financial returns. But they should not make ethical choices that financially disadvantage savers, unless savers have given informed consent.
“We do not think that the pressures towards short-term trading come from the law. There are many other factors at play, including actuarial valuations. Many pension schemes are very small. They lack internal resources and depend instead on investment consultants and investment managers, who may recommend short-term trading because that is what everyone else is doing.”
In its consultation, the Law Commission is asking whether the law has struck the right balance.
Contract-based pensions
Contract-based pension schemes do not have trustees and the law is much less certain. There are no clear legal duties on pension providers to act in the best interests of their members or to reassess the suitability of investment strategies over time. The Commission is seeking responses to its provisional view that the rules requiring contract-based pension providers to reassess the suitability of investment strategies over time should be clarified and strengthened.
In both trust-based and contract-based schemes, legal duties on their own may not be sufficient to ensure that pension schemes work in the interests of their members. The Commission notes the work being carried out by the Department for Work and Pensions to improve the governance of pension schemes, and urges consultees to engage with this work.
Other intermediaries
The consultation paper also considers the duties on other intermediaries in the chain, such as investment consultants, investment managers and custodians. In most cases, the law is uncertain.
David Hertzell said:
“Judge-made laws, such as fiduciary duties, cannot make up for gaps in regulation. We think that there may be gaps in the way that investment consultants and custodians are regulated, and ask whether there is a need to review these areas.”
The Law Commission seeks views on these issues by 22 January 2014.
Notes:
1. David Hertzell, the Law Commissioner leading on this project, is available for interview.
2. The Kay Review of UK Equity Markets and Long-Term Decision Making: Final Report is available here.
3. The consultation paper and a summary are available here.
4. For more details on this project, visit here.
5. The Law Commission and the Scottish Law Commission are non-political independent bodies, set up by Parliament in 1965 to keep all the law of England Wales and of Scotland under review, and to recommend reform where it is needed.
