The first thing to say about the Law Commission’s consultation on fiduciary duty, which is currently assessing feedback from respondents, is that it makes a number of good points. These include statements to the effect that:
• Given the growing financial significance of ESG factors, fiduciaries are entitled (though not required) to take environmental, social and governance (ESG) factors into account in making investment decisions or arrangements.
• Losing money in one part of a portfolio in order to enhance the portfolio in general makes sense. This is at least one part of the “universal investor” concept that big, diversified investors should consider acting in ways intended to raise markets in general rather than focusing solely on stock specific returns as if each company was an island.
• Fiduciaries may take into account the ‘quality of life’ impact of investments (their impact on the world in which beneficiaries will spend the money they receive) when choosing between investments or strategies that are equally beneficial in financial terms.
• Fiduciaries can (but do not have to) consult their beneficiaries about these matters.
• As well as avoiding investment in illegal activities, fiduciaries should avoid activities that contravene international conventions.
So what’s the problem?
The Law Commission moves from these statements to the position that fiduciary duty is OK as it stands (although they make a series of useful proposals about extending the range of circumstances in which fiduciaryduties should apply). This does little, however, to fix the problem that many trustees have had (and may continue to get) advice from their lawyers that is far more hostile to responsible investment than the position set out in the consultation. The key legal cases quoted in the Law Commission document rather make the point: some, but not all, of the five points listed above appear to be relevant. No doubt the Law Commission would argue that this is because fiduciary duty is flexible and able to adapt to new evidence and changing professional or investment practice. But the same picture emerges from the legal advice obtained by the Universities Superannuation Scheme (USS) and published on their website which was one of the starting points for their generally well-regarded approach to responsible investment. Only two of the five points listed above are made there.
Legal adviser says “no”.
I recall that when the UK ESG disclosure legislation was launched for pension schemes in 2000, the civil servants involved felt that making it a legal requirement for each pension fund to state where it stood on social, environmental and ethical issues would be a cunning way to get around a particular problem. Their problem was that ministers had clear advice from good lawyers that responsible investment by pension funds was legal (done properly). But they had also heard from many pensions trustees the equally clear message that the legal adviser says “no”. The same sort of ailment could arise again this time, and the same sort of medicine may be necessary.
So what could be done?
My single biggest “ask” relates to the rather curious fact that having been set up as a consequence of the Kay Review of UK Equity Markets and Long-Term Decision Making, the Law Commission consultation says very little
about the difference between protecting beneficiaries’ interests in the long term and in the short term (should those differ), and the effect of that aspect of fiduciary duty on markets. They suggest that other drivers of short-termism may be more important than fiduciary duty, which seems rather beside the point.
Solution: a clear and distinct obligation to look after the long-term benefit of beneficiaries
What I think the Law Commission needs to highlight or include in their proposals after consultation is a clear and distinct obligation upon fiduciaries to look after the long-term benefit of their beneficiaries alongside their duty to look after their short-term interests. It is possible that to a lawyer who deals with fiduciary duties the answer to the question: “Does a fiduciary have an obligation to protect the long-term interests of their beneficiaries as well as their short-term interests?” is so self-evidently “Yes” that they didn’t think it was worth exploring the point in much detail. But the implications of making it explicit (and this might require statutory or other clarification to be effective) would be that fiduciaries would need to consider separately whether there were any long-term threats to their beneficiaries’ interests, and if so whether they were properly taken care of in the investment arrangements on their behalf. In the far from hypothetical situation where they had reason to believe that many, if not all, of the best available investment options seemed excessively focused on the short term, trustees could not then rest easy.
How to illustrate this?
To take a completely non-ESG example, if there was good reason to think that interest rates were likely to rise, a fiduciary probably shouldn’t put all their beneficiaries’ money into a three-year bond at prevailing interest rates simply because it got a better interest rate today than other more liquid options. They need to think about (or take advice upon) how circumstances are likely to evolve.How does this apply to ESG issues?
If a fiduciary believes that the long term impact of good corporate governance or tackling climate change will be to increase the value of their portfolio, but the asset manager who they think will do the best job for them in the next three years isn’t that interested in either, then the fiduciary should be expected to address that problem directly.
What could they do?
One option would be to work with the manager to seek to change their view. Or, they could appoint a different manager for part of their assets. Alternatively, they could work collaboratively with other investors ‘as owners’ to address the issues that their manager seems to be ignoring. One way or another they should do something about the long-term threat or opportunity that they have identified in relation to their beneficiaries’ interests. In terms of helping to lengthen market time horizons it would be a good thing for fiduciaries to identify and act on such threats or opportunities. Making that obligation clear and distinct would reinforce the need to do so in their minds and avoid the danger that they are “captured” by the options available, rather than driven by their duty to their beneficiaries.
How could this be rolled out in practice?
Linking back to my earlier point about the effect of the UK pensions disclosure legislation, the best way to increase the chances that fiduciaries apply their minds to long-term risks, and to ensure the uptake of the Law Commission’s new thinking (which is welcome, but does require a “roll-out” plan), could simply be to require fiduciaries to include in the annual reports of their schemes a narrative discussion of how they have gone about carrying out their fiduciary duty. This should include explicit long-term thinking and action taken in the course of investing money on behalf of their beneficiaries.
Peter Webster is CEO of EIRIS, the ESG ratings and research agency.