Jane Murray
General Counsel
A new report from the Financial Markets Law Committee (FMLC), commissioned by the UK government, seeks to clarify a legal position on a pension fund trustee’s fiduciary duty when considering sustainability and climate change.
‘Pension Fund Trustees and Fiduciary Duties: Decision-making in the context of Sustainability and the subject of Climate Change’ explores pension fund trustee obligations today and how they will change over time. This paper is for pension fund trustees, but for that reason it is also relevant to advisers (including legal advisers and investment consultants) and investment or fund managers as the question of fiduciary duty is considered.
It offers concrete answers to several questions, including dispelling the argument that pension fund trustees can rely on current legislation and regulation alone. It also states that it would be “very difficult to accept” any fund trustee decision to “leave the causes and consequences of climate change out of account due to uncertainty.”
Covering the law of England and Wales, the report was produced by a working group of legal and pension professionals, led by High Court judge Sir Robin Knowles, as part of the UK government's Green Finance Strategy. Investor representation included experts from Nest Pensions, Willis Towers Watson, IFM Investors and many more.
A necessary consideration
First establishing the principle of fiduciary duty, the FMLC report explains that fund trustees are fiduciary because they are “someone who has undertaken to act on behalf of another”, creating a relationship of trust and confidence. This means they hold a duty of care on behalf of their beneficiaries, as well as an ‘obligation of loyalty’ to put investee interests before their own.
it is “the motive underlying its consideration” which distinguishes a financial factor from a non-financial factor.
They must first and foremost balance return against risk, considering financially material factors followed by non-financial factors. Whether sustainability and the subject of climate change is material or non-material has been the topic of much debate.
Offering some clarity, the report explains that it is “the motive underlying its consideration” which distinguishes a financial factor from a non-financial factor, rather than the nature of the factor itself. Trustees should also consider that financial factors are increasingly broad today.
In this context, sustainability may reduce risk, improve return, or align with the long-term interests of beneficiaries, making it a necessary consideration. Decisions might also be considered as part of a wider strategy to tackle “a sustainability risk to [the] financial performance of all or part of the fund.”
Crucially, it also establishes that it might be necessary to forgo short-term gains because they create “identifiable risks to longer-term sustainability of investment returns.”
“Straightforward no.”
The report goes on to explain that while funds should not be expected to become experts in climate science themselves, they should consider the views of governments, businesses, consumers and the public. That’s because these factors could in turn drive changes in behaviour, law, economies and finance, to name a few.
On the often-asked question of whether trustees can leave the relevance of climate change to current legislation and regulation, The FMLC is unequivocal: it is a “straightforward no.” As well as the wider factors discussed above, it explains that material developments might be sudden or made with retrospective effect, representing significant risk.
Omitting the subject of climate change from consideration because of its uncertainty is not a viable option.
Further, the response of governments, business, consumers and civil society to the subject of climate change may drive changes in behaviour and conduct, law and regulation, economics and finance or confidence and reputation, all of which go to the consideration of financial risk and return.
The report states that pension funds exist as part of a wider financial economic network. They are major allocators of capital across wholesale financial markets which span various geographies - all of which may be affected by the systemic risk of climate change. This means that careful consideration at an asset level, portfolio level and at the level of whole economies is required.
Omitting the subject of climate change from consideration because of its uncertainty is not a viable option, the FMLC explains, describing that concept as “very difficult to accept.” Though fund trustees who do give careful consideration to decisions are not judged in hindsight or expected to have perfect foresight, “matters of a systemic nature or carrying long-term implications are properly to be identified as such.”
Numbers and narrative
The emphasis on risk and long-term thinking will be familiar to investors but may need to be communicated more frequently to the real economy: “Pension schemes do not share the same purpose as a charity, environmental or otherwise”, the report makes clear.
Stewardship is "a logical progression of the ongoing exercise of investment power by trustees."
Situating a fund in the wider economy, communicating their strategy, and considering what they need from advisors and asset managers are some of the suggestions offered to pension fund trustees in the report. It also acknowledges that the challenges of sustainability and climate change are difficult to quantify: “Decision-making involves both numbers and narrative” it explains, with longer time horizons meaning a more speculative number. This means that a quantitative and qualitative approach is needed.
In what may be reassuring terms for investors using guidance such as the Net Zero Investment Framework, which focuses on real-economy decarbonisation, the report describes stewardship as “a logical progression of the ongoing exercise of investment power by trustees.”
From the first page to the last, the role of the pension fund trustee as the final decision-maker is made clear. They must use the advice of advisors and the support of the day-to-day nature of investment managers to do so, taking a uniquely long-term view on behalf of their clients and beneficiaries.
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