Pension Funds (Fiduciary Duties)
Jon Cruddas (Policy Review Coordinator; Dagenham and Rainham, Labour)
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,
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,
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 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.
Steve Webb (The Minister of State, Department for Work and Pensions; Thornbury and Yate, Liberal Democrat)
May I begin by congratulating Jon Cruddas on securing this debate, which raises issues that I know are of real concern for many people? As he pointed out, it is just over a year since we were both here debating the same subject. One of my colleagues who observed our last debate said that she felt that agreement was breaking out violently all over the place. I suspect that we may be in similar territory today, because I have a great deal of sympathy with the points that the hon. Gentleman raised.
To be clear from the outset, I should say that the coalition Government fully support the highest standards of corporate governance and ethical behaviour. We agree that a socially responsible investment strategy is a sound choice for pension schemes, and we recognise the importance of the issues raised by FairPensions. I welcome the fact that the points made by the hon. Gentleman chime with the emphasis that both the Prime Minister and Deputy Prime Minister recently placed on responsible capitalism. Although not directly related to the duties of pension funds, the call by my right hon. Friend the Deputy Prime Minister for much greater corporate transparency and the need to unlock shareholder power indicate the coalition Government’s intention of addressing some of the wider concerns raised by the hon. Gentleman today.
I would like to emphasise the significant contribution that FairPensions has made to inform the debate on these issues. I have had a number of discussions with it and, as the hon. Gentleman said, its director is now a member of our trustee panel and I joined her for a meeting earlier this week. I hope that he will be reassured that that perspective is very much in the room when these issues are considered.
The hon. Gentlemen touched on the important role of the investments of pension funds in fuelling economic recovery in the UK. As he rightly said, the Chancellor announced in his autumn statement that the Government have signed a memorandum of understanding with two groups of UK pension funds to unlock additional investment in UK infrastructure, including the National Association of Pension Funds, the Pension Protection Fund, to which I will return, and a separate group representing pension plans and infrastructure fund managers.
The Government are also establishing an infrastructure investment forum with the Association of British Insurers—he mentioned the role of insurance companies—which will explore ways to ensure that capital markets continue to provide an efficient and attractive source of debt finance for infrastructure projects. The Government will target up to £20 billion of investment from those initiatives, which we hope will lead to a step change in the use of pension scheme assets to fuel our economic recovery.
The hon. Gentleman referred to the FairPensions March 2011 report on fiduciary duty. I entirely agree that that has done a good job in raising awareness about some of the important issues relating to the role of pension trustees in the governance and conduct of firms, and the role of advisers. One of the concerns consistently raised by FairPensions is that the extent of a trustee's fiduciary duty is frequently misunderstood. As he said, I pointed out in the Pension Bill Committee, and am happy to say, albeit in front of a slightly more select gathering on this occasion, that I am absolutely clear that fiduciary duty does not simply mean that someone must maximise short-term investment returns at all costs. I am also clear—again on the record—that those duties do not prevent trustees from considering environmental, social and governance practices. Indeed, as part of the discharge of their fiduciary duty, it would be perfectly reasonable for pension trustees to ask searching questions about the environmental, social and governance practices of those firms their scheme was investing in. There is no reason why trustees cannot take ethical and governance issues into account when making investment decisions, solely subject to their making sure they comply with the legislative requirements relating to scheme investments, and the provisions of their scheme's statement of investment principles.
I come now to the hon. Gentleman’s point about 2012 and the direction in which we are travelling. We have seen only recently the closure of the final salary scheme of a FTSE 100 company open to new members—another mark in the move away from direct benefit pensions—and we are moving into a world of auto-enrolment, which will not exclusively be into contract-based defined contributions, but clearly many of the providers will be structured in that way, and I want to come on to that. As he says, between 5 million and 8 million people will be saving for the first time, or saving more, in a workplace pension. Against this backdrop, the hon. Gentleman’s points about how pension fund assets are managed, and more directly the fiduciary duty of those managing the assets, are very important. I am grateful to the hon. Gentleman for his comments about NEST being a beacon of best practice, and I will certainly look at the examples he gave of the Strathclyde pension fund and the recent Charity Commission guidance, which sounds helpful in this regard.
Looking beyond NEST—obviously the “t” stands for “trust”—clearly a key difference between trust-based occupational pension schemes and contract-based schemes that are used for automatic enrolment is the fact that occupational schemes have trustees who have a fiduciary duty to act in the best interests of the members. As he said, last year the Government issued a call for evidence on the regulatory differences between the two sorts of pension schemes. While some respondents, such as the hon. Gentleman, were concerned that there was no equivalent protection for the investments of members of workplace personal pensions, others pointed out that many providers of workplace personal pensions—contract-based—do have alternative arrangements in place, such as governance committees. It does seem to be the case that many employers are increasingly moving towards arrangements for employee engagement through the establishment of such management or governance committees.
Research by the Pensions Regulator has found that approximately half of employers with a contract-based scheme do have some form of governance arrangement over and above what is legally required. These range from a very informal review on an ad hoc basis by employer representatives, through to more formal arrangements involving a wider range of parties, which may involve employee representatives. I do recognise that that does not wholly equate with a trustee's fiduciary duty, since there is no obligation on an employer to establish such a committee, and where they do exist there is a wide variation in their terms of reference, membership and powers.
In May last year, my Department issued detailed guidance on default funds in auto-enrolment to ensure the quality of a DC pension scheme’s default fund. This will be vital to the success of automatic enrolment as most individuals will not be making a choice about their investment fund and will be enrolled into a scheme's default option. Reflecting on what the hon. Gentleman said, that gives us an opportunity for scale. If the vast majority of people end up in the default funds, and we can get the default funds right, there is potential for good practice to be spread quite widely.
The guidance sets out the standards that pension schemes, advisers and employers should follow to ensure that the default fund is of sufficient quality. Those standards cover charges, governance, risk management, review and communications. The guidance was developed with employers, the pension industry, consumer groups and advisers to ensure not only that it is user friendly but that it strikes the right balance between prescription and allowing flexibility.
On the question of charges, evidence suggests that the vast majority of schemes have appropriately low fund charges, but there is always a possibility that charges could rise to inappropriately high levels in the future. That is why we took powers under the Pensions Act 2008 to regulate and set a charge cap, should charges become inappropriately high, given that even relatively small differences in charges can have a big impact on someone’s pension pot. The hon. Gentleman will know that we extended those powers in the Pensions Act 2011, for which I was responsible.
In the meantime, other initiatives are progressing. Hon. Members might recall that the Investment Governance Group, an industry group jointly sponsored by the Pensions Regulator, the Department for Work and Pensions and the Treasury, has developed principles for best practice in investment governance of work-based pension schemes. That guidance was published shortly before our previous debate and comprises six principles covering the three stages of investment governance: governance structure, investment choices and monitoring, and communications. It is available on the Pensions Regulator’s website. The aim of the principles is to encourage better investment governance and decision making by all stakeholders, and to provide a practical checklist to benchmark a scheme’s investment governance processes against best practice.
Two additional pieces of work from that group might be of interest to the hon. Gentleman. First, the Pensions Regulator is working closely with the National Association of Pension Funds to produce a report on defined benefit case studies, and considering investment strategies and approaches to ethical investments. Secondly, the National
Association of Pension Funds is assisting the regulator in the preparation of a video podcast on the governance of small schemes, which I think will consist of at least two downloads. I understand that both those products should be ready for publication soon.
Much more recently, on
I want briefly to mention the Pension Protection Fund. Someone told me recently that, in five to 10 years’ time, the PPF will be the biggest pension fund in the land, which is a slightly depressing thought. It is an operationally independent arm’s length organisation that was set up by Parliament. Like NEST, the investment strategy of the Pension Protection Fund is an example of the Government seeking to promote best practice in investment strategy, in this case through a non-departmental public body. In its statement of investment principles, published in November 2010, the PPF board makes it clear that it will act in the best financial interests of the fund and its beneficiaries in seeking the best return that is consistent with a prudent and appropriate level of risk. The board believes that it must act as a responsible and vigilant asset owner and market participant, and take account of the environmental, social and governance factors that can have an impact on the long-term performance of its investment. There is therefore a stress on long-termism and active engagement by this major owner of corporate Britain. I am sure that the hon. Gentleman will also welcome the fact that the PPF board is a signatory to the United Nations principles of responsible investment, a set of best practice principles on responsible investment.
The hon. Gentleman asked about discussions with the Pensions Regulator. When we debated these issues in December 2010, he asked whether I would be prepared to raise the issue of transparency with Michael O’Higgins, who was then the incoming chair of the Pensions Regulator. I can confirm that I have had a number of discussions with the chair in the past 12 months, and that I have
drawn attention to the issues raised in the FairPensions report from March 2011, which have been echoed by the hon. Gentleman today.
Surprisingly, trustees are not obliged to disclose information about investments or their investment decisions to scheme members. It seems odd, given that it is our money, that we have so little ability to find out what is being done with it. The Pensions Regulator is therefore working with my Department to consider ways of introducing more transparency into schemes, and ways in which members could be better updated with information on their scheme. I shall be meeting the chair and the chief executive of the Pensions Regulator later this month, when we will discuss the issue further. I venture to suggest that it will be slightly higher on the agenda following the hon. Gentleman’s repeated interventions, for which I am grateful to him.
The hon. Gentleman mentioned the Kay review, which is obviously crucial. Professor Kay is examining UK equity markets and their impact on the long-term performance and governance of UK business. His independent review will consider a number of the issues that have been raised today, and its report is due later this year. Professor Kay kindly came to speak with me about the review on
The Kay review is examining the extent to which equity market participants are excessively focused on short-term outcomes, and what actions might be taken to address such problems if they exist. It will explore the incentives, motivations and timescales of all participants in the equity markets, as well as the fiduciary duties of pension funds and their role as long-term investors. I assure the hon. Gentleman that we will look very seriously at what Professor Kay has to say. I do not want to pre-empt that at this stage, but I will work closely with my colleagues in other Departments on any issues raised by the review that need to be considered further.
I thank the hon. Gentleman for his persistence. This is an important issue, and I hope that he will continue to raise it.
Question put and agreed to.