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Pension scheme trustees should look to longer-term investment risks, says Law Commission

Pension fund trustees can take non-financial considerations, such as ethical concerns or scheme members' quality of life, into account when making investment decisions in certain circumstances, even where this could have implications for investment performance, the Law Commission has said.

In a report on fiduciary duties, the law reform body for England and Wales said that trustees should invest to secure the best realistic return "over the long-term", rather than making decisions based on maximising returns in the short term. It has proposed new guidance for the trustees of trust-based schemes, and recommended that regulators consider the introduction of a statutory duty for the new independent governance committees (IGCs) of contract-based schemes to act in scheme members' best interests.

Pensions expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, said that the Commission was right to keep its recommendations for legislative change to a minimum. The Law Commission has recommended that its guidance for trustees should be included in a future industry Code of Practice by the Pensions Regulator.

"The Law Commission has rightly recognised that the law of fiduciary duties is complex and subtle," Tyler said. "The courts have carefully worked out over time what trustees need to do. It would be wrong to cut through all this with sweeping legislation that might have unintended consequences. Instead, the Law Commission has adopted the approach of proposing changes mainly through guidance, while keeping legislative change to a few specific points. This is the right approach."

"Trustees should welcome the Commission's new guidance on pension trustees' investment duties. The guidance draws a useful distinction between non-financial factors and financial factors. All pension scheme trustees should read this helpful guidance when they next come to making any investment decisions," he said.

The Law Commission was asked to consider the extent to which fiduciary duties, meaning the duty to act in the interest of another party, apply to those working in financial markets as part of the government's response to the 2012 Kay Review into short-termism in the UK's equity markets. Although its report and recommendations considered the issues through the "lens" of trust-based and contract-based pension schemes, some of its recommendations are relevant to all investment intermediaries and their advisers.

As part of its work, the Law Commission considered the difference between trust-based pensions, where trustees have a duty to act in the best interests of savers; and contract-based pensions. It concluded that trustees' duties required them to take into account "factors which are financially material to the performance of an investment", which did not necessarily exclude ethical considerations or environmental, social and governance (ESG) issues where these were "financially material".

In addition, the Law Commission said that the law was "sufficiently flexible" to allow trustees to take these factors into account if they were "non-financial", such as because they could improve members' quality of life or to show disapproval of certain types of investment. Trustees would be able to take these concerns into account if two tests were met: firstly, where they had "good reasons" to think that scheme members shared that particular concern; and secondly, where there was no risk of "significant" financial detriment to the scheme.

The Law Commission said that the duties of contract-based schemes to act in the best interests of their members were currently much less clear, although it noted that new measures to improve scheme governance were due to be introduced next year. From April 2015, providers of contract-based schemes will be required to operate IGCs to assess scheme value for money and report on how they meet scheme quality standards. The Law Commission has recommended that these also be given a statutory duty to act in members' interests with "reasonable care and skill".

"The government's March 2014 command paper, Better Workplace Pensions, aimed to provide sufficient clarity for providers to set up IGCs in 2014, pending new Financial Conduct Authority rules to be introduced from April 2015," said pensions expert Tom Barton of Pinsent Masons. "We are expecting further word from the Department of Work and Pensions on IGCs, amongst other things, towards the end of this month."

"The Commission's conclusions highlight that, with time running out, there is still uncertainty about the precise role and responsibilities of IGCs. The DWP may clarify some of the areas of uncertainty later in the month. There are a number of key questions that will need answers - these include what members' interests are; what 'value for money' is; what duties an IGC will have to take into account the interests of providers and employers; which schemes and which members will be covered by the constraints on member-borne charges; and what arrangements will be put in place for direct IGC engagement with members and employers," he said.

From April 2015, management fees on default funds in defined contribution (DC) pension schemes will be capped at 0.75% of funds under management. The cap will initially cover all member-borne charges and deductions, excluding transaction costs, on DC schemes used for automatic enrolment. The Law Commission has recommended that when this cap and the exclusion of transaction costs is reviewed in 2017, it should consider whether pension providers increased trading to make up for lower management charges.

The Law Commission has also recommended that the government consider requiring that trustees include a statement of their policy on stewardship (ie shareholder activism) in their statement of investment principles.  Pensions expert Simon Tyler said that this recommendation was a “nudge in the right direction for trustees.”

"Pension schemes should play a role in promoting the success of the companies they invest in," he said. "Anything that encourages stewardship by institutional investors, such as pension scheme trustees, is a good thing."

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