This article is one in a series of thought leadership pieces written for Responsible Investor by members of the European Commission’s High Level Expert Group on Sustainable Finance. To see other HLEG coverage, see here, or to comment, visit our discussion page.
To me, the CEO of an occupational pension fund, it is inevitably clear that our fiduciary duty must entail a long-term perspective. Not only that, we need a much broader conception of what risks and opportunities we must take into consideration in our investments. This is essential to fulfil the assignment we have been trusted with – to allow our fiduciaries to retire in a stable society, reassured that we have done our best to give their pensions as much value as possible. However, somewhere along the investment chain, this clarity becomes blurry, and as investors we sometimes fail to honour the long-termism throughout the mandates, and instead fall into traditional models and assessment criteria. That is why clarity on fiduciary duty may be a key to ensure that we avoid too narrow interpretation of risks and ensure that all actors along the investment chain take the long-term horizon into consideration.
Despite the fact that the legal concept of fiduciary duty is, in various degrees and forms, integrated in all EU Member States’ legal systems, the EU has never succeeded in harmonising a definition of fiduciary duty. A key concern brought forth against the lack of a consistent definition of fiduciary duty across the EU emphasises a too narrow interpretation of the concept, with emphasis on maximising short-term returns, failing to take into account factors that will have an impact on long-term value creation, and thereby allow for proper and adequate ESG considerations. To beneficiaries of pension fund trustees in particular, an inability to take into consideration long-term risk and opportunities – including ESG matters – may cost dearly given the long investment horizon.
Thus, a definition of fiduciary duties could have profound implications, as the decisions made by fiduciaries cascade down the investment chain affecting investment decision-making processes, ownership practices and ultimately the way in which companies are managed.
A definition of fiduciary duties could have profound implications, as the decisions made by fiduciaries cascade down the investment chain
“Fiduciary duty is a legal term that refers to the type of duty that a person or organisation, who manages someone else’s wealth or property, has in certain circumstances in relation to the owner or beneficiary of that wealth or property.” The legal term has been present in Europe and other countries for centuries. It was a legal term used in Ancient Greece, in China during the Confucius era and during the reign of the Roman Empire. The legal term has evolved over the centuries in order to conform to changes in society. However, the basic idea has prevailed across regions, legal systems and times: to protect beneficiaries’ from disadvantages due to information asymmetry between the trustee and the beneficiary. Hence, the legal concept requires in all material respect to put the beneficiaries’ interests first. This legal concept of fiduciary duty, as described above, is present in different shapes and forms in all the Members States of the EU.
As has been noted by, for example, J. Sandberg in 2011, it is a risk for a sustainable financial market that the obligation to put the beneficiaries’ interest first is reduced to financial interest.The interest of the beneficiaries should in addition to financial interest also entail ‘extra-financial’ interests and ethical ones. This will safeguard proper and adequate ESG considerations across the investment chain. It will furthermore provide for the necessary long-term perspective. Neglecting analysis of ESG factors in investment decisions would then, and should then, be seen as a failure to comply with fiduciary duty, leading to risks of poor asset allocation decisions and mispricing of risks. Whereas the updated IORP II Directive provides for clarification of a more defined ESG approach for pension funds, the current EU provisions for the actors of the investment chain has yet to provide impetus for allocation of capital towards more long-term and sustainable solutions.
It can also be argued that a clarified and enhanced definition of fiduciary duty in EU legislation, including long-term and ESG perspectives, may restore some confidence and trust in the financial system, following repeated incidents of lack of sound judgement, opaque investment strategies and products clearly designed for short-term holdings, at a cost to the ultimate beneficiaries. In this respect the requirement to avoid conflicts of interest would also be served by clarification, as the current provisions for pension funds and insurance companies clearly state that it is the best interest of the beneficiaries, members or policy holders, that is to be prioritised. For fund and asset managers, the formulations are less to the point, referring to steps to avoid conflicts of interest or disclose the nature and source of conflict.
In the UK, fiduciary duty is referred to in common law – a fiduciary being “someone who has undertaken to act for and on behalf of another in a particular matter which gives rise to a relationship of trust and confidence” or, put simply in the Kay review: “those who manage or advise on the investments of others”. The distinguishing duty of a fiduciary is the duty of loyalty, which entails avoiding conflicts of interest, and not making unauthorised profit citing fiduciary status. In practice, the interpretation of fiduciary duty in the UK spans from a strict legal definition to a more general duty of care.
And while there is no formal definition of fiduciary duty on EU level, there are key components that underpin the concept of fiduciary duty. Namely:
- The duty of loyalty: to always act in the interest of the beneficiaries and balance conflicting interests, and not to act in own interest.
- Duty to act prudently: to act with due care, skill and diligence, avoiding unduly risky investments, for instance.
Owners and asset managers representing vast capital interests are already implementing and integrating such measures, and we believe there is momentum for clearer provisions in the legislation for a harmonised approach across EU financial regulation that would procure that high fiduciary standards integrating ESG considerations are effectively applied across the investment and lending chain and the full array of financial instruments.
Magnus Billing is the CEO of Alecta, Sweden’s biggest pension fund, managing around $90bn of assets. Before that he was CEO of Nasdaq Nordic, which owns stock exchanges in Sweden, Denmark, Finland, Iceland and the Baltics.
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