UK: Pension Fund Investment: What Exactly Are "Members' Best Interests"?

Last Updated: 1 December 2015
Article by Kris Weber

Trustees' duties are to act in the best interests of their beneficiaries – everybody knows that. And "best interests" of course, generally means best financial interests. But what about where there is more to a matter than financial considerations – ethical investments, for example, where trustees might wish to take a decision on more subjective grounds and then impute to scheme members the desire for financial considerations to play second fiddle? Just how thin is the ice that they're standing on...

Arthur Scargill, thirty years on

This year marks the thirtieth anniversary of the ground-breaking decision of the High Court in Cowan v Scargill, in which it held that trustees' personal, subjective views about the ethical (or indeed unethical) nature of a particular investment could rarely 'trump' their duty to act in the best interests, i.e. best financial interests, of a scheme's beneficiaries.

The case concerned the investments to be undertaken by the trustees of the National Coal Board pension fund (and yes, the "Scargill" is indeed the Barnsley FC supporter you are thinking of) and was concerned, in particular, with whether the trustees could properly decide not to invest in anything that was in competition with the coal industry, even though doing so might result in lower financial returns than might otherwise have been the case. Remember, for context, that the events in question took place in the early 1980s at the height of the miners' strike, shortly after Margaret Thatcher had been elected as Prime Minister and at a time when "flying pickets" were being bussed around the UK to prevent miners who wished to work from crossing picket lines; and tensions were running high. The specific purpose of the investment strategy was to further the business prospects of those involved with UK coal. It was challenged by the employer-nominated trustees on the board, who felt that the strategy – which was heavily influenced by the National Union of Mineworkers' political views – was of doubtful legal veracity.

The court made it quite clear just how far trustees could go, in letting their subjective views about a particular investment take precedence over their duty to the fund's beneficiaries:

"The starting point is the duty of trustees to exercise their powers in the best interests of the present and future beneficiaries of the trust...

This duty of the trustees towards their beneficiaries is paramount. They must, of course, obey the law; but subject to that, they must put the interests of their beneficiaries first. When the purpose of the trust is to provide financial benefits for the beneficiaries, as is usually the case, the best interests of the beneficiaries are normally their best financial interests. In the case of a power of investment, as in the present case, the power must be exercised so as to yield the best return for the beneficiaries, judged in relation to the risks of the investments in question; and the prospects of the yield of income and capital appreciation both have to be considered in judging the return from the investment...

In considering what investments to make trustees must put on one side their own personal interests and views. Trustees may have strongly held social or political views. They may be firmly opposed to any investment in [examples given]. In the conduct of their own affairs, of course, they are free to abstain from making any such investments. Yet under a trust, if investments of this type would be more beneficial to the beneficiaries than other investments, the trustees must not refrain from making the investments by reason of the views that they hold."

Back to the future

Fast-forward thirty years, maybe courtesy of a flying Delorean DMC-12 (a car manufactured in Northern Ireland and made predominantly out of fibreglass), and Marty McFly and the mad professor would clearly be intrigued to find themselves reading a report by the Law Commission which rather seemed to be going over old ground.

The Law Commission's report, published during summer 2014, had its roots in the Kay Review of UK Equity Markets, which found there to be considerable uncertainty in relation to investment decisions and the application of fiduciary duties. As a consequence the Government instructed the Law Commission to investigate fiduciary duties, including the extent to which fiduciaries (such as pension trustees) may, or must, consider:

  • Factors relevant to long-term investment performance which might not have an immediate financial impact, including questions of sustainability or environmental and social impact;
  • Interests beyond the maximisation of financial return; and
  • Generally-prevailing ethical standards, and/or the (actual or likely) ethical views of (some or all of) their beneficiaries, even where these might run counter to those persons' immediate financial interests.

The report concluded that trustees should take into account factors which are financially material to the performance of an investment, including long-term considerations. Where trustees think that ethical or ESG (environmental, social and governance) issues are financially material they should take them into account. The report also stated the Law Commission's conclusion that, whilst the pursuit of a financial return should be the predominant concern of pension trustees, the law is sufficiently flexible to allow other, non-financial concerns to be taken into account provided trustees have good reason to think that scheme members share their view, and that there is no risk of significant financial detriment to the fund.

All of which, to me at least, seems eminently sensible. So why, therefore, have some recent press reports made such a big deal about how the Government has rubbished the Law Commission's proposals and recommendations?

Government consultation: fiduciary duties in an investment context

With all due respect to the popular press (and I'd be the first to admit that a little bit of racy hyperbole makes a good story!), the Government has actually done nothing of the sort. The Government was asked by the Law Commission to investigate two particular angles arising from the report, which it has done. The Government has, of course, now decided to do nothing about them (in light of the consultation exercise, to which I shall turn in a minute). But to suggest that the whole Law Commission report is on shaky ground would, I think, be a tad unfair.

The Government's consultation exercise focused on:

  • Whether what is now a statutory requirement under regulation 4 of the 2005 Investment Regulations, to invest in the best interests of members (and other beneficiaries), should be extended to pension schemes with fewer than 100 members (which are currently carved out of this obligation by virtue of regulation 7); and
  • Whether the requirement under regulation 2 to refer in a scheme's Statement of Investment Principles, to the extent to which "social, environmental or ethical considerations" are taken into account in the selection, retention and/or realisation of investments, should be clarified so that it more accurately reflects the distinction drawn by the Law Commission between financial and non-financial factors.

The Government recently published the outcome of the consultation exercise and its conclusions that, in the light of the responses received, no changes to the law were felt necessary.

Insofar as investing in the best interests of beneficiaries is concerned, the Government felt that no action was necessary because 'smaller' schemes already seem to be complying with the requirements of regulation 4 (as part of their general trust law duties). And whilst it did express general support for the Law Commission's recommendations relating to non-financial factors in investment decisions, the Government felt that the diversity of responses – coupled with it not being clear how the actual drafting of the regulation could be improved – tended towards a "leave well alone" approach to this issue.

So where does that leave us?

No further forwards, on one interpretation. Confusion and misunderstanding over the extent to which pension trustees should be considering long-term environmental issues when investing their fund's assets may well perpetuate.

However, whilst the law is rarely perfect (and certainly isn't here), if it isn't too badly broken why try to fix it?

Added to which, the Law Commission's work seems in any event to be having a beneficial impact. In particular, the Government feels that the evidence demonstrates how pension trustees do now have a good awareness of their duty to consider factors, including ESG factors, which may be material to the performance of their investments over the longer-term. And down on the South Coast, the Pensions Regulator has been hard at work updating its trustee training materials; is currently updating its DC Code of Practice; and will in due course, we understand, be incorporating the Law Commission's findings into its investment guidance more generally.

So we might, after all, be in a better position than we used to be. And at least from a cognitive perspective, trustees do seem increasingly aware of the existence of these issues, even if answers to them are still eluding all of us.

If in the future Deep Thought (or, for that matter, HM Government) should find us a more definitive conclusion, we shall be the first to let you know!

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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