Short-termism: the screw tightens: a legal opinion on the government’s Kay progress report

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The best revolutions pass almost unnoticed. So it is with the steady shift in the investment paradigm from irresponsible short-termism, treating shares as mere tradeable commodities, to long-term sustainability, assessing potential investments on wider criteria.
On October 27, The UK Department for Business, Innovation and Skill (BIS) published its update on the implementation of the Kay Report. This expressly adopted the recommendations of The Law Commission earlier this year on fiduciary duties up the investment chain. Those recommendations, despite their crucial importance, went almost wholly unnoticed in the public sphere, until the eminent journalist John Plender highlighted them in a (paywalled) FT article published with impeccable timing earlier that day.
The Law Commission
Asked by BIS, on the recommendation of the Kay Report, to investigate this topic, the Law Commission eschewed changing statute law, but (a) gave formal guidance to pension trustees and (b) recommended regulatory changes, primarily to reinforce such guidance.
Law Commission Reports are well researched and much appreciated by specialist lawyers for their scholarship and erudition. They are not, however, renowned for their ease of reading! In a welcome departure from this tradition, the Summary Report in this case has appended to it an almost racy six-page Guidance to Pensions Trustees when setting an Investment Strategy, snappily entitled: “Is it always about the Money?” Both the Summary Report and the Guidance are (separately) available on the Law Commission’s website
The Guidance gives a brief and fluent analysis of the legal background, and then sets out to describe and delineate the factors that should guide an investment processwhich is by definition long-term, and in doing so attacks the conventional “red-braces” City perception that, in Professor John Kay’s words, “some pension fund trustees equated their financial responsibilities with a narrow interpretation of the interests of their beneficiaries which focussed on maximising financial returns over a short timescale and prevented the consideration of longer term factors which might impact on company performance, including questions of sustainability or environmental and social impact.”
It is the delineation that is novel. The “red-braces” view is the narrow one stated above. The Law Commission takes a radically different view. It states that investment is about balancing the risk/reward ratio, and that environmental, social and governance (ESG) factors are intrinsic to this balance, not some airy-fairy, extrinsic bolt-on. It limits “non-financial factors” to value judgments, i.e. where trustees believe that beneficiaries would make such judgments, and that their incorporation into the investment strategy would not cause significant financial detriment to the fund. It gives the example of withdrawing from investment in tobacco companies: to do so because of the risks of diminishing returns flowing from legislative challenges is rooted in financial factors, to do so because killing people is immoral is a value judgment. This statement of the legal position does not change the law. Very much as with the statement of Directors’ duties in the 2006 Companies Act, it clarifies it in the public domain with sufficient clarity and authority that it can no longer be denied by the “red-braces” culture.
The BIS Response
In its most recent Progress Report on implementing Kay, BIS welcomes the Law Commission’s findings, expressing the hope that they will “remove any remaining doubt that fiduciary duties
require trustees to focus on maximising short-term returns”. It then demonstrates in detail how it is not only addressing the Law Commission’s recommendations for regulatory changes to reinforce its Guidance but also pressing regulators and representative bodies in the pensions and investment industry, in polite civil service language, “to convey the Guidance to their members”. Hopefully that means that every relevant handbook of hundreds of pages of (mainly unread) legalese will henceforth print the Guidance in bold type at the front.
“It’s the Culture, Stupid!”
So the law is now clear beyond peradventure, and is being entrenched in regulation. That is all to the credit of both the Law Commission and the Government, and constitutes a significant achievement for LibDem Ministers.But, whereas clarifying and entrenching the law is an event, changing a culture is a process that inevitably takes longer. And it is particularly difficult in the pensions industry, where amateur trustees rarely feel sufficiently self-confident to challenge their professional advisers who have hitherto competed for market share by quarterly performance leagues.
So there is much more to do. The advent of NEST as a growing player, and the introduction of collective DC schemes, will certainly assist the necessary cultural change. And one can but hope that, by a modern reversal of Gresham’s Law, good practice in the investment management industry will drive out bad.

Philip Goldenberg is a solicitor specialising in Company Law and Corporate Governance, and a consultant with Michael Conn Goldsobel. He was the Legal Adviser to the Royal Society of Arts’ TOMORROW’S COMPANY Inquiry in the mid 1990s, and then advised the Government’s Company Law Review on the topic of Directors, Shareholders and Stakeholders. He has recently worked with Government Ministers, TOMORROW’S COMPANY, ShareAction and The Law Commission on the issues discussed in this article.*