Fiduciary duty includes systemic ESG and inter-generational obligations – NSFM

Submission to Law Commission review by the Network for Sustainable Financial Markets

Any definition of fiduciary duty should incorporate systemic environmental, social and governance and inter-generational obligations, according to a thorough new work on the subject from the Network for Sustainable Financial markets, the group of finance sector professionals and academics which promotes long-term investing.

The network was responding to the UK Law Commission’s initial review into fiduciary duty sought by the government in the wake of the Kay Review on UK Equity Markets and Long Term Decision Making.

The Law Commission, the UK’s law review body, expects to open a full consultation by October and produce a final report by June 2014.

“We see systemic, environmental, social, governance and financial effects of investment decisions as all within the bounds of issues that must be considered and weighed by fiduciaries today, particularly those like perpetual endowments or pension funds with long-term and cross generational obligations,” the network says in its 12-page submission.

“In fact, failure to take these real world ramifications into consideration strikes us as exactly what the duties of loyalty and impartiality are designed to prevent – ignoring future risks and costs associated with current decisions merely because the decision maker finds it more convenient to disregard factors not included in its established analytical model.”

The commentary notes that much has changed since the 1985 Cowan v. Scargill legal ruling which, along with Harries v Church Commissioners case, has informed thinking about fiduciary duty in the UK.

“For example, the current systemic influence of fiduciary investment decisions, carbon risk, ecological limits, reputational risks and stakeholder expectations would require a more sophisticated fiduciary analysis of issues involving application of the duty of impartiality to human beneficiaries.”The NSFM reckons the Law Commission’s ultimate recommendations will be of great significance “both in the UK and elsewhere”.

It’s argued that a too-rigid interpretation of the fiduciary duty of prudence has favored the status quo, artificially suppressing demand for investment advisors and consultants to update their business models and discouraging fiduciaries from leaving the safety of the “herd”. Twentieth century perceptions of fiduciary duty, the NSFM argues, “are simply not fit for purpose today”.

The submission, spearheaded by the network’s Fiduciary Duty Working Group Co-Chairs Keith Johnson and Frank Jan de Graaf – and signed by a range of leading RI figures in a personal capacity – argues that fiduciary responsibilities should be applied broadly to all involved in the investment of assets on behalf of others. It suggests the Law Commission could recommend clarification of this important concept.

“We do not see how trustees, investment managers, advisors, consultants, insurance companies and others who exercise discretion over management decisions, or those who exert controlling influence over discretionary management decisions by fiduciaries, cannot themselves be considered fiduciaries.”

The document also raises the question of whether fiduciary duty should seen as a moral code given that fiduciaries’ collective allocation of capital is systemically important and that the costs of “externalities” are no longer irrelevant to beneficiaries.

“While these issues might strike some as involving a moral code, we see them as fundamentally tied to real world inter-generational issues of fairness regarding financial obligations owed to human beneficiaries.”

The commentary concludes: “It is incumbent upon the Law Commission to heed findings of the Kay Report and take action that will hasten the uptake of a more mature understanding of fiduciary duties that reflects current knowledge and circumstances.”