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Fiduciary Duty: UK urged to review short-term asset manager appointments at local authority funds

Major report into fiduciary duty published by Law Commission

The UK government has been urged to review legal requirements that force local authority pension funds – under the Local Government Pension Scheme (LGPS) framework – to appoint their asset managers on a short-term basis and review them on a three-monthly basis.
It picks up on criticism in the government-sponsored Kay Review of market short-termism of the way investment managers are given short-term appointments – which is seen as contributing to market ‘churn’.
“We therefore think it would be helpful to review the requirements … that the administering authority must be able to terminate an investment managers’ appointment by not more than one month’s notice; and that the manager must report to the administering authority at least once every three months,” said the Law Commission in its much anticipated final report on fiduciary duty.
It’s one of a slew of recommendations to come out the review prompted by the Kay process.
The report stops short of advocating a change in the law around fiduciary duty, preferring instead to attempt to clarify existing rules, particularly with regard to how pension trustees address environmental, social and governance (ESG) factors.
As the report states [Paragraph 6.29 p. 112]: “We hope that we can finally remove any misconceptions on this issue: there is no impediment to trustees taking account of environmental, social or governance factors where they are, or may be, financially material.”
The impetus for the review was a widespread view that pension fund trustees equated fiduciary duty with a narrow interpretation centring on maximising short-term financial returns.

The report notes there is confusion around the terminology around ethics and ESG and says: “The key distinction is between financial and non-financial factors. Financial factors are any factors which are relevant to trustees’ primary investment duty of balancing returns against risks.A non-financial factor is one motivated by other concerns, such as improving members’ quality of life or showing disapproval of certain industries.”
It goes on: “When investing in equities over the long-term, the risks will include risks to the long-term sustainability of a company’s performance. These may arise from a wide range of factors, including poor governance or environmental degradation, or the risks to a company’s reputation arising from the way it treats its customers, suppliers or employees.” Where poor business ethics raise questions about a company’s long-term sustainability, “we would classify them as a financial factor which is relevant to risk”.
It is for trustees’ discretion, acting on proper advice, to evaluate which risks are material and how to take them into account, the Commission says in its 271-page tome.
The body, which reviews law in England and Wales, is also calling for the government to review 2005’s Occupational Pension Schemes (Investment) Regulations, specifically its reference to “social, environmental or ethical considerations” – to ensure that it accurately reflects the distinction between financial factors and non-financial factors. And it is also recommending a review as to whether trustees should be required to state their policy (if any) on stewardship.
Another recommendation contained in the report is for the Pension Regulator to add the new guidance into its ‘trustee toolkit’ as an initial move. In the longer-term, the guidance could be incorporated into the regulator’s code of practice.
The role of investment consultants in the investment chain also comes under scrutiny, with the report seeing the lack of regulation as “anomalous”, adding that it would ask the government to actively monitor the issue. One possibility was for the government to commission independent research. “If specific risks become apparent, further regulation would be justified.” Link