The legal basis of the principles applying to how pension fund trustees exercise their investment powers derive from fiduciary and trust law principles, which are complemented by the relevant pension fund’s governing documentation and legislation. Complicating the interpretation of these duties is the recent wave of regulation on environmental, social and governance (ESG) investing, which, initially, imposes mandatory reporting requirements around ESG and stewardship policies and, in many cases, governance of climate change risks and opportunities. This area of regulation is expected to expand in the future to cover items such as transition plans in support of the country’s net zero emissions goals. In this context, each of the pension fund trustees’ duties need to be considered carefully.
First, there is the question of what “investing for sustainability impact”, “ESG investing” and “impact investing” mean—and how, if at all, they differ from one another. Even outside the context of pension funds, there are complexities in relation to how financial institutions may engage in such investment activities and how fiduciary duty interfaces with the legal and regulatory framework for financial services.
Pension fund trustees are expected to exercise their fiduciary duties when investing, and above all to use the investment power prudently and for its proper purpose. In law, the proper purpose of the investment power is to allow trustees to allocate the fund’s assets in order to achieve the overall purpose of the fund—i.e., to provide retirement benefits to the pension fund’s members. Conventionally, this has been interpreted as meaning that trustees’ investment decisions require consideration of a range of financial factors connected to investment return. Increasingly, however, it has been argued that investment decisions and the fund’s portfolio may have a wider social and economic impact which may in turn be material to the fund’s investments over time. For instance, a company’s approach to ESG factors may present risks to its future financial returns (or, conversely, opportunities for new and more sustainable long-term returns). Other companies may be impacted negatively in the course of a transition to a low-carbon economy. Pensions trustees are having to grapple with questions around how “financially material” factors may be defined, particularly given the fact that this may be dependent on the type of scheme, the time horizon of the investments and potentially other considerations written into the governing documents, and how they may be weighted in comparison with traditional factors. How risk is analysed and measured in relation to ESG factors and how much risk is acceptable remain unclear.
Turning to explicitly non-financial factors, in 2014, the Law Commission published a report drawing a clear distinction between trustees’ ability to take “financial factors” and “non-financial factors” into account in their investment decision making. In 2017, the Law Commission published a second report, building upon the analysis of the first, and recommended that legislation be amended so as to require pensions trustees to “[evaluate] risks to an investment in the long term, including risks relating to sustainability arising from corporate governance or from environmental or social impact”. Nevertheless, a degree of uncertainty persists, particularly about when pensions trustees may consider whether to take into account and how to weigh non-financial factors, and where the dividing line between “financial” and “non-financial” factors actually lies. This has been further complicated by recent case law on “ethical” investment by pension schemes.
A joint meeting of the Insurance and Pensions and ESG Scoping Forums was held to examine the questions above. Jonathan Gilmour (Travers Smith LLP), Ida Levine (Impact Investing Institute), Andy Lewis (Travers Smith LLP), Luba Nikulina (Willis Towers Watson) and David Rouch (Freshfields Bruckhaus Deringer LLP) helped shed light on the complex decision-making process pension fund trustees must consider, in conjunction with investment management advice. The discussion sought to identify issues of legal uncertainty on which the FMLC might weigh in.
The meeting agenda and slides used by some speakers are available to download.