Defining fiduciary duty

What constitutes fiduciary duty is an ongoing discussion in the pension sector. The UK Law Commission has weighed in on the debate with its own interpretation.

Pension funds mulling the definition and obligations of their fiduciary duty can now refer to a consultation paper from the Law Commission, Fiduciary Duties of Investment Intermediaries.

The principle enshrined in law that requires clients’ interest are put first, that charges are reasonable and disclosed and that conflict of interest is avoided, is often difficult for pension funds to interpret and enact.

It was one of the issues highlighted in last year’s Kay Review of UK equity markets and Long-term Decision-making.

The UK Law Commission has added its weight to the debate with its own insight into how far the law reflects an appropriate understanding of the scope of beneficiaries’ best interest and the idea around fiduciary duties requiring trustees to maximise financial return in short-term gains.

It also asks to what extent trustees can consider other factors, such as environmental and social issues in their fund’s investment strategies; whether fiduciary duties can encompass investment in ethical strategies even where this may not be in the immediate financial interest of beneficiaries.

The Law Commission has found that fiduciary duty is interpreted differently throughout the pension sector.

On one hand the term is used by pension trustees to emphasise their ethos to act in the interests of the beneficiaries.

Many trustees link their status as fiduciaries with a sense of altruism, says the paper. Trustees contrast their special status as fiduciaries with the focus of others in the investment chain on making money.

“Many interpret it in the strict legal sense of a relationship in which the principal is reliant or dependent on the knowledge, expertise and discretion of an agent, and to which the strictest duties of loyalty and prudence are applicable. Others however use the word fiduciary to describe a more general duty of care,” found the Law Commission.

Paddy Briggs, trustee at the £13 billion ($20 billion) Shell Contributory Pension Fund, has adopted a pragmatic approach to a role he has held for the last four years.

“Whatever the law says it is just as important to apply common sense and natural justice,” he says, adding that a successful pension fund involves co-responsibility between the sponsor, professional managers and advisors and trustees.

“You have to have this three way acceptance of responsibility. The natural tendency is not to look at the law but at what makes sense.”

The Commission found lawyers tend to think of fiduciary duty in terms of litigation, meaning investors should be able to sue based on breaches of the standards within the definition.

“There are elephant traps but it is unlikely that a well managed fund would fall into one,” says Briggs.

Chris Hitchen, chief executive of the £19 billion ($30 billion) Railways Pension Trustee Company who served on the advisory board of the Kay Review, offered his definition of the term when he spoke at the Business Innovation and Skills Committee earlier this year.

“I would say that fiduciary duty is a concept that occurs a few times in Kay’s report and it really goes to the core of my job. It is not the same thing as doing what your members want you to do; it is doing what is in their best interests, and those two things are not always the same.”

Short termism

The Commission suggests that regulatory pressures in defined benefit schemes, and limited resources in both defined benefit and defined contribution schemes, are mostly to blame for short-termism.

It’s a view that the National Association of Pension Funds agrees with.

“We are of the view that the fiduciary duties of trustees of pension plans are reasonably clearly understood and there is sufficient scope under current law as currently understood for trustees to take a longer term view,” says Will Pomroy head of corporate governance at NAPF. “If encouragement of longer term investment strategies is a goal then reforms to accounting standards  (IAS19) would be a more effective way to combat the causes of short-termism.”

But speaking back in March, Hitchen did urge for new ways for funds to measure success.

“Success should not be about beating the market today or tomorrow. To an extent that makes it incumbent on us as trustees and trustee representatives to find different ways of measuring success. It would probably have to be around: “Have you contributed real value to my pension schemes assets over many years? Rather than, “Have you beaten the market last quarter.”

The Commission found that trustees may take environmental, social and governance issues into account, but they should not attempt to “improve the world in some general sense” if this is possibly at the expense of future savers.

It’s an idea expressed in the £34 billion ($54 billion) University Superannuation Scheme’s responsible investment strategy, shaped around the idea that the fund can and should take ESG issues into account in its investment decision making, but only where the issues are material to performance.

“USS is not permitted to make investment decisions based purely on an ethical or moral stance,” according to the fund documents, and it has developed an active engagement approach, but does not undertake ethical screening or operate exclusion policies.

The debate will continue long after the Law Commission’s final report appears in June 2014.