Legal body publishes ‘groundbreaking’ review of UK fiduciary duty and sustainability

Market welcomes clarification around sustainability issues from the independent Financial Markets Law Committee.

gavel hammer law antitrust justice legal

An influential UK legal body has published a review of sustainability and fiduciary duty for pension schemes in a bid to reassure trustees considering sustainability factors and climate change.

The Financial Markets Law Committee (FMLC), an independent body that works to identify and provide clarity on areas of legal uncertainty in financial markets, published its verdict on the fiduciary question on Tuesday.

Schemes in the UK have repeatedly cited uncertainty around fiduciary duty as a barrier to integrating climate and sustainability when setting investment strategy and making decisions, and have called for regulatory clarification.

The FMLC warned that its paper should not be taken as advice or interpreted as encouraging trustees in any specific direction, but said “the relevant entry point for consideration of sustainability in the context of pension funds is as a financial factor rather than as a non-financial factor”.

“Within that framework, sustainability is therefore for consideration in all pension schemes,” it added.

The paper said trustees should not look at climate change solely through the lens of what is required by current regulations and legislation as that approach “would not address all the risk”.

The consideration of climate change could involve new dimensions, the FMLC said, noting that trustees may need to consider “whether a strategy should reject shorter-term gains because they create identifiable risks to the longer-term sustainability of investment returns in the fund”.

Trustees may also need to reappraise that, where economic or systemic climate issues may previously have been characterised as “too remote and insubstantial”, physical, transition and litigation risks are now apparent and material, the paper said.

It added that it was “unlikely” that portfolio diversification will be enough to avoid climate risk, given its systemic nature.

Paul Lee, head of stewardship and sustainable investment strategy at investment consultant Redington and a member of the FMLC working group, told Responsible Investor that the greater certainty provided by the paper “should enable more trustees to incorporate their understanding of climate change more fully into their investment approach”.

“The FMLC paper makes clear that as long as trustees consider climate change (and other sustainability factors) through a financial lens – that is, considering their impact on investment risk and return, in the context of the pension fund’s portfolio as a whole – incorporating them is wholly consistent with fiduciary duty,” he said.

“There’s a challenge for lawyers and investment consultants in the paper that we will need to rise to – making sure that we frame our advice to trustees in ways that assist them to be clear they are acting in a way that’s consistent with fiduciary duties. Let’s hope the professions are ready for that challenge.”

The FMLC working group was chaired by Robin Knowles, a high court judge, and included representatives from a number of pension schemes and investment consultants, legal academics and the Impact Investing Institute.

Law firms including Freshfields Bruckhaus Deringer, Sackers and Clifford Chance were also represented.

Other working group members and those in the wider industry also welcomed the publication. Maria Nazarova-Doyle, global head of sustainable investment at IFM Investors and a working group member, described the review as “ground-breaking” and said it makes an “incredibly important contribution” to the debate.

James Alexander, CEO of UKSIF, said the group believes FMLC’s guidance “delivers the clarification necessary to make fiduciary duty legislation much more effective in its purpose”.

“We urge ministers and regulators to support the findings of the FMLC and continue to monitor the impact of these clarifications amongst fiduciaries and their advisers,” he added.

Claire Jones, head of responsible investment at consultancy LCP, said the paper “should go a long way towards clearing up the uncertainty which has hindered this complex topic”.

“All trustees should read the paper and actively consider climate change when making decisions in future, not just rely on advisers and investment managers to have done that for them,” she said.