Pension Funds (Fiduciary Duties)

Jon Cruddas Excerpts

Friday 20th January 2012 Commons Chamber

[Jon Cruddas (Dagenham and Rainham) (Lab)]

I wish to make a few comments on the fiduciary duty of pension fund trustees. It is just over a year since the Minister and I stood here to discuss the issue of responsible investment by pension funds, and in that debate we focused particularly on transparency for fund members. So to begin with it is worth taking stock of a few developments that have occurred since we last discussed these issues.

First, in recent weeks, the notion of “responsible capitalism” has risen to the top of the political agenda. A cross-party consensus has emerged that shareholders must do more to tackle irresponsible corporate behaviour such as excessive top pay. Secondly, we have entered 2012, the year of auto-enrolment, a process that will ultimately see millions of workers begin saving for a pension through the capital markets. Thirdly, casting our minds back to the autumn statement, we have seen the Government turning to pension funds as a source of capital to fuel the economic recovery through infrastructure investment.

If we put all that together, it becomes clear that the way pension funds invest is no longer, as the Minister put it in our last discussion, “a minority sport”, but a matter of acute national concern. Although much has been made of the rise of foreign investors, UK pension funds still make up 13% of the UK stock market, with insurance companies that provide pension products making up another 12%. So it is vital that this huge pool of capital is invested responsibly in the long-term interests of pension savers. Unfortunately, as a report published last year by responsible investment charity FairPensions showed, current interpretations of the law may hinder that objective. Fiduciary duties—our main legal mechanism for protecting those who entrust their money to someone else—do not apply consistently across the pensions market. Worse still, they are generally interpreted as forbidding pension funds from raising their sights beyond quarterly returns. Far from protecting savers’ long-term interests, that view may in fact be damaging to them.

Clarification of this seemingly obscure and technical area of the law could unlock positive change in a range of areas: supporting jobs and growth; ensuring decent pensions; and underpinning the shift to a more responsible, resilient capitalism. The Prime Minister has indicated that the Government want to give shareholders more powers to block excessive pay deals. That is obviously welcome, but more searching questions need to be asked about how shareholders are using the rights they already have. Figures released by PIRC—Pensions Investment Research Consultants Ltd—last week showed that since the introduction of the advisory vote on pay 10 years ago just 18 remuneration packages have been voted down, despite the fact that pay has risen out of all proportion to shareholder returns. Why has there been such reluctance to use these powers?

Most pension funds do not exercise voting rights themselves, but delegate to fund managers, whose duties are unclear. FairPensions’ report argues that fund managers have fiduciary duties under common law—a view shared by the Law Commission—but that is not generally accepted by the industry. That means that the strict duty to avoid conflicts of interest is not being applied to the people actually making the decisions. That has real implications for the way in which votes are cast by City fund managers who have business relationships with the companies in which they invest.

A recent article in Butterworths Journal of International Banking and Financial Law cited anecdotal evidence of

“corporate or investment banking staff overtly or subtly pressuring their asset management colleagues to avoid antagonising their clients by voting against the CEO’s pay arrangements.”

Meanwhile, pension funds are often labouring under the misapprehension that their fiduciary duty prohibits them from taking an interest in Bob Diamond’s bonuses, for example, when, of course, properly understood, that is very much part of that duty.

The pervasive myth that fiduciary duty begins and ends with maximising returns leads many funds to neglect intangible factors—excessive pay or poor environmental standards—even though they may well affect the long-term returns that matter most to pension savers. The misconception seems to put some trustees off being active owners of the companies in which they invest, notwithstanding efforts through the UK stewardship code to encourage them to do so. Still less do funds believe that they can take account of the moral outrage felt by their members over excessive pay deals.

Such interpretations continue to hold back pension funds’ potential to play their part in a more responsible capitalism. To put it simply, we cannot have responsible capitalism if the capitalists think that the law prohibits them from acting responsibly.

I want briefly to return to the subject of transparency, which we talked about a year ago. Making companies more accountable to shareholders will not be enough to tackle “crony capitalism”: shareholders must also become accountable to the ordinary savers whose capital they invest. Among other things, that means much greater transparency about what is being done with our money. At the moment, if I want to know how my pension fund voted on Barclays’ remuneration report, for example, it is not obliged to tell me. In his response last year, the Minister promised to raise the issue with the chair of the Pensions Regulator. I would be grateful if he updated the House on the results of their conversation and on any further developments.

Narrow interpretations of fiduciary duty risk holding back not only the responsible capitalism agenda but the economic recovery. Pension savers have a clear interest in the health of the UK economy. It affects not only the growth of their investments but their economic well-being more generally as UK citizens, jobholders and taxpayers. The Treasury has picked up on that and observed that obvious common interest when encouraging pension funds to invest in UK infrastructure. The Financial Secretary to the Treasury said in a recent speech to the National Association of Pension Funds:

“Your investment in the UK economy can drive economic change and that change should generate more stable and sustainable returns, benefitting Britain’s pensioners.”

The same logic can be applied to investment in the small and medium-sized companies that are the engine of future job generation in our economy, but that is not the logic that underpins pension fund decision making in practice. We are back to the mantra of the fiduciary duty to maximise returns, which dictates that return must be sought wherever it is found. Given a direct choice between two competing investments, there is no reason for pension funds to invest in the UK rather than, say, China. Indeed, most funds would say that the law legally obliges them to choose the latter if the risk-return profile is even marginally more attractive.

That reduces fiduciary duty to a mathematical calculation that obliges trustees to chase the best return and ignore all other considerations, rather than enabling a more common-sense approach, using their discretion to determine how their capital can best be put to work for the benefit of pension savers. Given the choice, many pension savers might well want to see their savings invested in British industry or green infrastructure but, under conventional interpretations of the law, their views are irrelevant. Fiduciary duty, which exists to protect savers, risks becoming a missing link when it comes to translating our savings into productive investment activity.

This is emphatically not about hijacking pension funds’ capital to serve government ends; that could be a dangerous road to go down. It is all about allowing them the discretion to take a broad and enlightened view of what is in the beneficiaries’ interests, rather than prescribing an approach that might not serve savers in the long run. Let us not forget that it was today’s interpretation of the law that saw pension funds pile into triple-A-rated shares in banks whose risky activities ultimately decimated pension fund value. If funds had been encouraged to think about the sustainability of those returns, rather than just the share price, their beneficiaries might have been better served in the long-run.

That brings me to the third area in which policy makers ignore debates about fiduciary duty at their peril—auto-enrolment. The Pensions Regulator estimates that between 5 million and 8 million people will be newly saving, or saving more, as a result of the 2012 reforms. Many of those people will be low-paid workers and there is a huge responsibility on the Government to ensure that their savings are responsibly stewarded and deliver a decent retirement income. This means ensuring that fiduciary standards of care can be applied across the pensions market.

In Committee on the Pensions Bill, the Minister rightly noted the importance of taking a “holistic approach” and not creating “unevenness” by putting

“conditions that are not imposed on other investment vehicles on pension schemes”.––[Official Report, Pensions Public Bill Committee, 14 July 2011; c. 330.]

However, there is already unevenness between trust-based pension schemes and contract-based pension arrangements, as the latter are not subject to fiduciary duties and the governance requirements that go with them. The average saver may struggle to see the difference between those two types of arrangements, but the legal niceties mean that savers are subject to completely different legal protections depending on the type of scheme their employer chooses. Last year the Minister’s Department consulted on “regulatory differences” between trust and contract-based pension arrangements and I hope he will look at this issue of governance because it is the single biggest regulatory difference and carries the biggest danger of regulatory arbitrage.

A struggling employer could be forgiven for wondering why they would want to set up a trust-based scheme with all the governance implications that would entail when they could simply choose an off-the-shelf product from an insurance firm. However, there are obvious reasons for thinking that such a decision might not serve the best interests of their employees. This is not merely a theoretical objection. I understand that FairPensions is due shortly to publish research showing that the absence of clear obligations does indeed create a “governance gap”. Can the Minister indicate whether his Department is looking into this issue and, if so, what might be done to ensure that a level playing field for all pension savers can be established?

The overall point is that the misapplication of fiduciary duty is clearly a significant challenge to the Government’s vision for a strong, responsible economy and a generation with a savings culture. Conversely, a renewed understanding of fiduciary duty offers an exciting opportunity to reshape our economy for the better. The FairPensions report recommends there should be statutory clarification of fiduciary duties along the lines of directors’ duties under the Companies Act 2006 to make it clear that pension funds can consider a range of factors beyond quarterly returns such as the impact of their investments on the wider economy, environmental and social issues and their members’ ethical views. It also recommends that the Department for Work and Pensions should produce guidance for pension fund trustees on the interpretation of their fiduciary duties.

When those recommendations were debated through a probing amendment to the Pensions Bill, the Minister helpfully put on record his view that

“it is not the duty of trustees simply to maximise short-term returns.”––[Official Report, Pensions Public Bill Committee, 14 July 2011; c. 329.]

In other words, the measures proposed by FairPensions that I have talked about would amount to clarification rather than a radical departure from existing legal principles in terms of trustees’ duties. This might prompt some to ask whether statutory definition is really needed if the underlying legal principles are sound.

Some pension funds already take an enlightened approach to their fiduciary responsibilities. The National Employment Savings Trust —NEST—is emerging as a beacon of best practice when it comes to responsible investment, viewing it as part of its responsibility to undertake shareholder engagement and to integrate environmental and social issues into its investment analysis. Similarly, the Strathclyde pension fund offers an excellent example of how pension funds can make investments that add genuine, sustainable economic value for their members. It recently announced a £100 million new opportunities fund to invest in job creation in Glasgow with the proviso that it will invest only in businesses that pay the living wage. However, those examples are very much the exception rather than the rule. The conventional interpretation of the law is highly conservative, and this is reflected in the legal advice received by the vast majority of pension funds. It is difficult in practice to see how this problem with the interpretation of the law can be overcome other than with an explicit clarification of the law.

It is also worth noting that even pension funds that take an enlightened view of their fiduciary duties still appear to believe that the law restricts their room for manoeuvre in this area. For instance, one investment officer recalls asking for legal advice on whether, when voting on a hostile takeover bid, they could consider the fact that some of their beneficiaries might lose their jobs. The answer was no; they could consider only the price that they would be paid for selling their shares. In other words, far from being a counterweight to predatory activities, even the most enlightened pension fund may feel legally obliged to be complicit in these predatory activities. For all these reasons, express clarification does seem to be necessary.

To be clear, this is not a question of diluting the fiduciary duty to seek the best outcome for beneficiaries. Nothing in these proposals would change the fundamental principle that fiduciaries must act wholly in the best interests of their beneficiaries. Rather, it is about making fiduciary duty work better in today’s complex financial markets. Indeed, we must seriously ask whether fiduciary duty as currently understood is doing its job properly.

From 2002 to 2007, pension fund payments to intermediaries rose by some 50%, while returns collapsed to an average of 1.1% per year. If the main purpose of fiduciary duties is to make sure that savers come first and that agents do not profit at their expense, these figures suggest that something is badly wrong. It is not a question of imposing new regulatory burdens on pension funds, but rather the opposite: clearing away perceived legal barriers and restoring common sense to the law.

FairPensions’ proposals are aimed at creating an enabling environment, freeing trustees from the fear that they may face legal liability if they depart from received wisdom about how they must invest. This is true of both the recommendation for statutory clarification, and the recommendation for DWP guidance.

In relation to guidance, I tentatively suggest that the Charity Commission’s recent update of its investment guidance for charitable trustees might prove a useful departure point. It has helped to clarify that fiduciary duty is not a set of handcuffs that prevent trustees from considering anything but financial return. In particular, it has sought to give comfort by stating that

“if trustees have considered the relevant issues, taken advice where appropriate and reached a reasonable decision, they are unlikely to be criticised for their decisions or adopting a particular investment policy.”

I understand that the Minister’s officials have been engaging with FairPensions since the publication of their report about the possibility of guidance, and I wonder whether the Minister might update the House on any progress that his Department has made on this recommendation.

Of course, I understand that the Government might wish to wait for the results of the Kay review of UK equity markets before making firm commitments. I understand that fiduciary duty forms part of Professor Kay’s remit, and that it has been discussed extensively during his first phase of consultation. If Professor Kay does make recommendations on this issue, the Government will clearly need to consider those alongside the recommendations already made in the FairPensions report.

Overall, therefore, it would be helpful if the Minister gave some general indication of whether there is enthusiasm in Government for reform of fiduciary duty, and whether, if it proves to be consistent with the findings of Professor Kay’s inquiry, he will work with colleagues in the Department for Business, Innovation and Skills to take forward this agenda.