The Law Commission’s attempt to make DC schemes conform on fiduciary duty, stewardship and ESG

The UKSIF chief exec responds to an important new report

The Law Commission has today (June 23) published an important report, Pension Funds and Social Investment. The title is a bit misleading; in making it clear that social investment is legally permitted, the Law Commission redoubles its efforts to clarify the status of more conventional ESG investing. Some barriers to social investing are addressed but the big change in this report is a full frontal attempt to make contract-based DC schemes conform to the Law Commission’s generally excellent work on fiduciary duty, stewardship and ESG.
The report makes five recommendations. These are aimed at making it clear that “social investment” is permitted by pension funds of all types in the context of the Law Commission’s thinking on fiduciary duty in its 2014 report.
Recommendation one is for the pension regulations to be changed such that trustees have to state their policies in respect of evaluating ESG risks and considering members’ ethical concerns.

Recommendation two is for the regulations to be changed so that trustees of both DB and DC schemes have to state their position on stewardship. Both repeat calls from 2014.
This is the second time in three years that the Law Commission has asked the Government to change the pension regulations to reflect the Commission’s thinking on ESG and stewardship. Can the Government refuse again?
The Commission recognises that the bulk of pension money available for social investment will eventually be DC, and also that The Pension Regulator’s (TPR) guidance on ESG won’t apply to those funds. To address this, in recommendations three and four the Law Commission calls on the Financial Conduct Authority (FCA) to change its regulations such that Independent Governance Committees, bodies in contract-based DC scheme governance which are a bit like trustees, are required to report on their approach to ESG, Stewardship and members’ ethical concerns.

This mirrors the position on fiduciary duty for trust-based schemes as interpreted by TPR. Recommendation five is also key: it asks the FCA to issue guidance to pension providers on the key issue of financially material factors and it wants this guidance to follow that of the TPR.
These have been long-term UKSIF asks. If these recommendations are followed, ESG and stewardship will come to contract-based schemes via regulation.
Having made it clear that all funds should be put in a position whereby they can “do” social investment, the Law Commission turns to practicalities in the social investment field.The suggestions here are labelled “options for reform”. The first three suggest a financial register which will make it easier for some charities to issue bonds; a review of dividend rates from community interest companies (“CICs”); and a possible merger of two regulators covering CICs and Co-operatives. These steps seem to be ways of making it easier for bodies to provide social investment opportunities- addressing, presumably, the supply gap to which many people refer.
The big opportunity for the social investment of pension assets highlighted in submissions to the Law Commission is in property and infrastructure, and the message was that there are problems of practice and understanding in these areas.

“The Law Commission wants its thinking on fiduciary duty to become the standard for all pensions”

The problems relate to liquidity in funds and frequency of valuation. UKSIF said in its submission that the practice of daily pricing owed more to convenience and caution than investment need. That has clearly been echoed by others and in two options for reform the Law Commission asks TPR to advise funds on balancing prompt processing of transactions with holding illiquid assets, and asks the FCA to address similar issues in its regulations. Progress here would tend to increase the quantum of funds available for investment in social assets.
Liquidity is obviously linked to scale and the Law Commission has looked at this question. It suggests a review of whether member consent is needed for scheme mergers. The other suggestion in this area is a bit of a surprise: it is suggested that pension trustees be compelled to review each year whether their members are disadvantaged in respect of other funds by small size. Finally in this section, charges in assets such as property are an issue and the Law Commission suggest DWP monitors developments.
The report then returns to “social investment” and the suggestions may imply that faced with differing views the Law Commission didn’t know what to recommend. It is suggested that the Government push pension providers to agree a terminology for social investments, and that the Government push the industry to develop examples of good practice in “impact reporting”. In connection with terminology the Law Commission says they do not favour an “accreditation scheme”.

UKSIF thinks that view is not shared throughout Government- although the post-election position is not clear.
The final option for reform in the report is another surprise. The Law Commission suggests that the Government considers whether pension scheme members be periodically asked for their views on social investment and non-financial factors (i.e. ESG). That would be interesting, to put it mildly!
UKSIF welcomes this report which echoes things our members have been asking for some years. The Government should change the investment regulations and the FCA should reflect ESG in its regulations with respect to IGCs and pension providers.
The technical suggestions in social investment seem sensible and may increase the supply of investment opportunities.The suggestions with respect to liquidity are to be welcomed. Suggestions on scheme size and member views may be more contentious: investment shouldn’t necessarily be swayed by short-term swings in public opinion, and if pooled funds are big enough access to many asset classes should be possible for even smaller funds.
But it is the push for changes in the pension regulations and for changes by the FCA that stand out. There can be no doubt that the Law Commission wants its thinking on fiduciary duty to become the standard for all pensions, whether trust or contract based.

Simon Howard is Chief Executive of UKSIF.