Pension Funds

Jon Cruddas Excerpts

Tuesday 14th December 2010 Commons Chamber

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

Somewhat earlier than I anticipated, I rise to make a few comments about the operation of pension funds and their transparency.

Everyone knows that the world of pensions is changing fast. With the decline of defined benefit schemes and the shift to defined contribution, pension savers are shouldering more and more of the investment risk to their savings, and with the advent of auto-enrolment in 2012, even more people’s future well-being will be bound up with the capital markets through their pension funds. These trends make greater transparency of pension fund investments an urgent imperative for three reasons. First, if ordinary savers are bearing the risk to their investments, it is only right that they should be in a position to scrutinise how their agents are managing those risks. If we expect individuals to take more responsibility for providing for themselves in old age, they should at least be given the tools to hold accountable those on whom their retirement security depends.

Secondly, the huge—and hugely profitable—industry charged with looking after people’s savings has an extremely poor record. In recent decades, we have seen the growth of an enormous cadre of agents and intermediaries who extract huge fees at the direct expense of ordinary savers at the bottom of the investment chain. For instance, a report published last week by the Royal Society for the encouragement of Arts, Manufactures and Commerce—known as the RSA—found that the total fees charged by pension funds swallow up an astonishing 40% of the end value of the average British pension, which is much more than in our European counterparts. One might at least expect that this is paying for superior skills and therefore higher returns on investment, but pension fund returns are actually declining: between 2000 and 2009, they collapsed to an average of 1.1% per year. Paul Woolley at the London School of Economics has calculated that excessive short-termist trading in shares is likely to erode rather than enhance the long-term value of pension pots. Pension fund investment strategies are a very real issue for any Government who are serious about tackling the looming pensions crisis, which we all acknowledge.

The third reason transparency matters is that pension funds are huge institutional investors with enormous collective influence on the financial markets and the wider economy. If the financial crisis taught us anything, it was the danger of handing over ordinary people’s money to financial institutions and assuming that they will take care of it without the need for further scrutiny. The interests of pension savers are, by definition, long term, yet in the build-up to the financial crisis, many pension funds engaged in the same short-termist strategies and herding behaviour as the rest of the market.

The American academic Keith Johnson has described the influence of these investors as akin to unleashing

“a flock of 900-pound lemmings”

into the economy. There is, therefore, a legitimate public interest in how pension funds behave, including in how they exercise their ownership rights. The financial crisis exposed the dangers of share owners acting like what Lord Myners dubbed “absentee landlords” or, worse still, actively encouraging their investee companies to pursue short-term profit at the expense of the long term. Ultimately, it is millions of ordinary people who provide the capital and suffer the economic consequences when that capital is not used responsibly. The case for greater transparency is compelling.

So what should that mean in practice for the Government? Earlier this year, the Financial Reporting Council published a stewardship code for institutional investors aimed at encouraging responsible ownership. It is far from perfect, but it is a start. In particular, its strong focus on transparency, including transparency in the exercise of voting rights, is welcome. However, there is a danger of the interests of pension savers being forgotten in this process. The code’s provisions on voting disclosure are a tacit recognition that people have the right to know how the voice of shareholders is being used on issues such as executive pay, takeover bids or environmental resolutions. However, the code is largely aimed at asset managers.

Ordinary people cannot be expected to know which asset manager their pension fund uses and proactively to seek out that manager’s disclosures. Improvements in fund manager transparency will give savers the accountability and visibility that they deserve only if pension funds play their part too. Disappointingly, although the FRC has stated that pension funds have an important role to play, the pensions regulator has not yet produced any official guidance for pension funds on how they should apply the stewardship code. The role of pension funds has often been left to the National Association of Pension Funds, which is an industry body—a less-than-ideal situation, I tentatively suggest. Does the Minister agree that it would be appropriate for the pensions regulator to look into the matter? Will he raise it when he next meets the regulator’s newly appointed chair?

Notwithstanding what I have said so far, it is clear that the stewardship code will not be a panacea when it comes to accountability and transparency. FairPensions, the campaign for responsible investment, yesterday published an analysis of fund managers’ performance on transparency, including their reporting under the stewardship code. Although it showed some improvements, almost one in six asset managers surveyed still did not disclose any information about their voting records. One manager justified that by saying that it was up to the clients—that is, the pension funds—to disclose such information. However, recently published guidance from the National Association of Pension Funds makes it clear that it thinks that disclosure is up to the asset manager and is not the pension fund’s responsibility. There is a real danger that such buck passing will result in nobody disclosing and the pension savers at the bottom of the chain remaining in the dark about how their money is being managed.

The Government could avoid that danger by doing two things. First, they could make voting disclosure mandatory for asset managers by exercising their reserve powers under section 1277 of the Companies Act 2006. I understand that this is not within the Minister’s gift, but I hope that it will be considered by his colleague the Secretary of State for Business, Innovation and Skills, as part of his review of economic short-termism. Secondly, the Government could clarify pension funds’ obligations in this area by amending the regulations, which already require pension funds to disclose their voting policy, to make it clear that they should also disclose information about their voting practices. Alternatively, that could be included in the pensions regulator’s guidance.

I do not believe that either approach would impose an unreasonable burden on pension funds. If their fund managers are already required to report on their exercise of voting rights, it should be sufficient in most cases for pension funds simply to provide a link to that information on their websites. That would be a small matter for the fund in question, but a huge improvement in accountability for the pension saver. It would also make information directly accessible to the pension saver—instead of them being expected to go hunting for it—and would help to embed transparency right down the investment chain. In the US, the duty of disclosure is now a recognised part of pension funds’ fiduciary duties towards their beneficiaries. That is right, and I hope that we can move down that road here.

Those in the investment industry who are unwilling to open themselves up to scrutiny in that way have come up with various arguments over the years to defend their secretive business models. Most such arguments—the idea that such a proposal would be enormously costly, or compromise commercial confidentiality or even damage relationships with the company—have been comprehensively discredited over the years. The latest argument appears to be that it is pointless to require investors to disclose such information because nobody would read it. The Minister should be able to tell us that this argument is nonsense. I understand that in June he received some 1,500 e-mails from supporters of FairPensions asking him to support their right to access such information.

Earlier this year, more than 6,000 people contacted their pension funds to ask how they would be voting on shareholder resolutions about tar sands at BP and Shell’s annual general meetings. As it turned out, those savers’ concerns about the risks of unconventional oil extraction proved well founded, at least in the case of BP. Those pension funds might have found themselves in a better position financially if they had listened to their members a little more. There is clearly a growing movement of people who want to know what is being done with their money—a movement that is being held back by a pervasive lack of transparency and a culture of hostility to the people whose money is at stake having the impertinence to ask questions.

That brings me to the final point that I want to stress. It is vital that any moves towards greater transparency pay enough attention to environmental, social and governance issues—sometimes known as ESG. Survey after survey has shown that savers care about such issues. The rise of socially responsible investment products and the success of campaigns, such as that on the tar sands resolutions, show that people want to act on that concern, but they must be given the information and the tools to do so. The previous Government sought to give them that information some 10 years ago, by introducing regulations requiring pension funds to state the extent to which they take environmental, social and ethical concerns into account in their investment policies.

Since then, the G in ESG—governance—has received a huge amount of attention, after it became obvious that conflicts of interest, excessive pay and poor risk management contributed to the financial crisis. Yet with typical myopia, many investors still neglect the E and S of ESG—the environmental and social. The Deepwater disaster, which forced BP to cancel its dividend for the first time since the second world war, should have been a wake-up call for anyone who still doubted that companies that ignore such issues face serious financial risks. It should also have been a wake-up call for pension funds—for which the BP dividend was a significant source of steady income—to pay attention to such issues as a key part of their fiduciary duty to pension savers, as the legal opinion obtained for the United Nations Environment Programme confirmed some five years ago.

The challenge of climate change makes recognition of that duty even more urgent. Climate change is not only an investment risk, which it clearly is; it also has innumerable ramifications for the retirement security of the next generation of pensioners. A 25-year-old pension saver clearly has a broad interest in ensuring that his or her savings are reducing rather than increasing the risk that they will grow old in a world ravaged by catastrophic climate change.

The Ministers responsible for the 2000 regulations clearly intended to nudge pension funds into taking account of non-financial issues. To some extent they were successful, as the UK Sustainable Investment and Finance Association noted, in marking the 10th anniversary of the regulations. ESG integration is more mainstream than it was 10 years ago, but there is clearly still a long way to go. It would be wrong to say that the objectives of the 2000 regulations have been achieved. A 2009 United Nations report expressed “disappointment” that investment consultants still advise pension funds to include boilerplate statements on environmental, social and ethical issues that

“meet the letter but not the spirit of the law.”

Members who ask about specific voting decisions are often directed to such generic statements, which are of little or no use to them. Indeed, that is exactly what happened to Members of this House who inquired about their own pension fund’s stance on the tar sands resolutions earlier this year.

Research by FairPensions also suggests that such box ticking is often not accompanied by much substantive action. Its 2009 survey of pension funds showed that almost all had a policy stating that they took non-financial issues into account, but around a third did not integrate the policy into their agreements with fund managers or assess their fund managers’ ability to implement it, nor did they require them to report on its implementation. It is reasonable to ask what those funds were doing to implement their stated policies. It is also reasonable to ask how those policies gave any meaningful insight to the curious member wanting to know what their fund was doing about environmental and social issues. As the UN report concluded,

“the time may have come to review how”

the disclosure regulations’

“effectiveness could be improved with additional reporting and disclosure requirements that will supersede mere ‘tick box’ compliance.”

In other words, perhaps we need a further nudge, some 10 years on from the initial regulations.

I understand that the Minister’s official position is that the existing regulations are adequate, but in a recent parliamentary answer, his colleague Lord Freud confirmed that his Department has made no assessment of how the regulations are operating. Given that so many others who have done such analyses have concluded that change is needed, will the Minister commit to exploring how the situation might be improved? Guidance from the pensions regulator on stewardship could provide an opportunity to clarify what constitutes an adequate policy under the 2000 regulations, encouraging pension funds to go further than boilerplate positions.

Perhaps more importantly, the Government could require pension funds to report on a regular basis on how they were implementing that policy. That could be helpful in focusing minds and ensuring that these policies are not, as one fund manager described them, a “dead document” but a genuine commitment that is given full weight in investment decisions. Again, this is not an unreasonable thing to ask. Pension funds are already required to produce an annual report, including an investment report. Under the stewardship code, it is reasonable to assume that this should include a summary of their stewardship activities during the year. It is also reasonable to assume that the report exists to give pension savers meaningful information with which to judge the fund’s performance. Environmental and social issues should be no exception to this. There is popular demand for such information, and that demand should be met.

I hope I have shown that pension funds’ behaviour as responsible investors, including with regard to environmental and social issues, is neither a trivial sideshow nor an issue that concerns only policy makers dealing with corporate governance or financial services. It has real implications for our ability to meet the challenge of providing a decent pension, and a decent standard of living, for all our citizens across the country.

To recap my questions to the Minister: will he discuss these matters with the pensions regulator? Will he encourage the regulator to produce some guidance? And will he look again at the disclosure regulations and explore ways in which they could be updated or supplemented to ensure that pension savers are getting the levels of transparency that they deserve?