New Clause 12 - Occupational pensions schemes (investment)

Pensions Bill [Lords] – in a Public Bill Committee at 3:00 pm on 14 July 2011.

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‘(1) The Occupational Pension Schemes (Investment) Regulations 2005 are amended as follows—

(a) after regulation 4(2) insert—

“(2A) The powers of investment, or the discretion, must be exercised in the way considered, in good faith, most likely to promote the interests of the scheme for the benefit of its members and beneficiaries as a whole, having regard (amongst other matters) to—

(a) the likely consequences of any decision in the long term;

(b) the impact of the scheme’s investment activities on the stability of the financial system and on the economy;

(c) environmental, social and governance considerations, inlcuding the environmental and social impact of the scheme’s investment activities;

(d) the desirability of the scheme maintaining a reputation for high standards of commercial conduct;

(e) the desirablility of ascertaining and of taking into account the views, including the ethical views, of members and beneficiaries in relation to the scheme’s investment policy; and

(f) the need to act fairly as between the members and beneficiaries, including as between present and future members and beneficiaries.”,

(b) in regulation (4)11, insert—

““benefit” means—

(a) financial benefit; and

(b) any non-financial benefit which the trustee considers can be conferred on members and beneficiaries without any material prejudice to their financial benefit.”’.—(Cathy Jamieson.)

Brought up, and read the First time.

Photo of Cathy Jamieson Cathy Jamieson Labour, Kilmarnock and Loudoun

I beg to move, That the clause be read a Second time.

My hon. Friend the Member for Edinburgh East will be greatly relieved to see me standing on my feet at this point, although she may wish to contribute later. I am  conscious of the time, so I will not speak at great length on the new clause. However, there are a number of issues that I would like to put on the record.

All of us are concerned—we have heard a great deal of consensus on that, if I may use that word again—with the principle of auto-enrolment. We all want to ensure that the scheme goes ahead as smoothly as possible and gives comfort to as many people as possible that it will be of benefit to them in their later years, when they have ceased working. One of the potential effects of auto-enrolment will be a reliance of an estimated 5 million to 8 million individuals on the capital markets for the distribution of pension schemes on reaching retirement age. It is vital to analyse the current system of how pension funds are structured and how they operate, to ensure that the increasing number of people who depend on such funds are protected from risk.

This is a probing amendment, as I am sure the Minister appreciates. I am also sure he understands that I am keen to hear what he has to say. That will become clear when he hears the specifics that I am calling for. What Ministers say on the record may give clarification and comfort for those who must interpret legislation at various stages. The amendment calls for a review, or at least clarification, of the current legal obligations on those who manage people’s savings in funds to work towards and to protect their best interests.

The Minister is well aware that pension fund trustees are subject to stringent obligations known as fiduciary duties, which require them to act in the best interests of members. However, those are common law duties, so they are not specifically spelled out in statute. All hon. Members will have received information from the FairPensions campaign, which highlights that one consequence has been significant and growing confusion about the nature and scope of those duties. If that is considered alongside the predicted effect of auto-enrolment, it is crucial that the notion of fiduciary duty is understood and applied properly to ensure good investment outcomes for all such funds and trusts.

My main point is that legal clarification of those fiduciary duties would be helpful in any event, but would also help to lay the foundations for building confidence in pensions generally, and specifically auto-enrolment. Those duties exist to ensure that those entrusted to act on behalf of others do not abuse the trust placed in them to further their own ends. As a result, fiduciaries have a duty of loyalty that requires them to put the best interests of their beneficiaries first, and to avoid any conflict between that duty and their own self-interest. Yet there is concern that that core protective purpose seems increasingly to have been subsumed into a mythical notion of a single fiduciary duty to maximise returns. It is perhaps being interpreted too narrowly as short-term out-performance of the market instead of longer-term benefits. I tabled the amendment because it is right to probe further the extent to which this is a problem, and to look for ways in which the duty can be clarified.

It has been argued that at best there is confusion about the issue, with a propensity of fund and trust managers seeming to look for short-term gains, and that at worst there are questions about the boundaries of where their duties lie. My concern is that many trustees and managers are either afraid or unwilling to  consider the wider impact of long-term risks and factors, such as climate change or systemic financial risk, that would impact on their portfolios, but perhaps cannot be easily quantified in the short term.

Such factors may have a significant impact on investment outcomes, particularly for younger pension savers with long time horizons. We have only to look back at the Deepwater Horizon disaster at this time last year to realise the potential risks to savings and pensions that stem from short-termism in trust and fund management. Before the disaster, BP was the largest dividend payer in the UK, but in the subsequent period, it had to suspend its dividend payments, and when they resumed they were half their previous level. It is important to register the significance of that. BP had been warned about its poor record of health and safety in the past, and greater acknowledgment of long-term social and environmental risks on behalf of trust and fund managers could have resulted in greater pressure on BP to correct those health and safety problems and, by implication, perhaps limited or avoided the disaster last summer.

The Bill has been debated in another place, and Lord Freud acknowledged that there were important issues in relation to BP. He said:

“There has been a consensus in many previous debates on social and environmental issues that companies perform better when their activities are monitored by shareholders…One has only to look at what happened to BP last year with Deepwater Horizon to see that a greater concern, and perhaps some pressure on the BP board by its shareholders in relation to environmental issues, might have been especially valuable to the company.”—[Official Report, House of Lords, 15 March 2011; Vol. 726, c. 27-28.]

In the aftermath of the financial crisis, pension funds lost, on average, 17% of their value. It is now widely accepted that institutional investors did not do enough to challenge risky strategies in the banks that they owned, which would have protected their members from such impacts.

We need a proper understanding of the law, which, arguably, requires trustees to have regard to wider factors. Yet many trustees continue to believe that to do so would be a breach of their fiduciary obligations and they might therefore be exposed to the risk of being sued. Such matters must be clarified. From that perspective, we argue that there should be a greater acknowledgement of the importance of environmental, social and governance risks and factors in fiduciary obligations.

It can also be argued that acknowledging the potential harm and damage of risks is, or should be, part of the fiduciary obligation of protecting the interests of pension fund beneficiaries. Company directors are already required, in fulfilling their duty to promote the success of their company, to have regard to long-term and wider issues, such as environmental and social impacts. Those provisions were introduced by the Companies Act 2006 and were based on the principle of enlightened shareholder value. It is reasonable to suggest that we should have similar provisions, or at least a similar interpretation, in relation to pension funds.

The problem is that shareholders themselves are not subject to those parallel provisions, and many continue to believe that the law prohibits them taking a similarly enlightened approach. It is therefore unsurprising that the progress generated by the 2006 Act has been disappointing, and directors report feeling under increasing pressure from their investors to maximise short-term  returns. In one study, some 78% said that they would prioritise wider issues, even if doing so meant sacrificing longer-term business success. That is a particular issue in relation to pension funds. Essentially, I am calling for the Minister to provide information on what he might be able to do to give a legal clarification of the meaning of fiduciary duty. Such a clarification would align that duty with the interests of the millions of savers who are soon to be auto-enrolled.

We might align fiduciary duty and the interests of savers across the UK through greater integration of environmental, social and governance factors on behalf of fund managers. That view is backed up by empirical evidence that has been provided to hon. Members by the FairPensions campaign, which has shown that the incorporation of those risk factors can reduce risk without damaging levels of returns. I have been very supportive of and take a great interest in the mutual sector and ethical investments. However, I do not suggest in the new clause that we move towards solely ethical investments, although I might do so personally. I was interested to see that the report suggests that the historical performance of the eight largest US mutual funds compared with the eight largest responsible funds, as they have been described, shows that funds that chose to incorporate and integrate environmental, social and governance factors delivered higher risk-adjusted returns over both one-year and three-year periods.

In addition, a United Nations Environment Programme report, which used a range of methods including benchmarking, scenario analysis and case studies, concluded that

“there is robust evidence that ESG issues affect shareholder value in both the short and long term.”

It also stated:

“The impact of ESG issues on share price can be valued and quantified.”

The FairPensions document concluded that there is no robust evidence that prudent ESG integration is damaging to returns.

I therefore ask the Minister to say what his Government intend to do to address the problem that has been identified. With the legal understanding of fiduciary obligation and duty, many fund managers are unwilling to accommodate or integrate ESG into their portfolio or model at present. I am sure that the Minister will share my principles. When the Pensions Bill comes into effect, I would like to see us move away—the term “nudge” has been used a great deal in the Committee, and a firm nudge from the Minister would be fine—from short-termism in the attitudes of some towards pension and trust fund management, and for those obligations to be clarified to protect the interests of millions of savers across the UK. I am sure that the Minister will share those principles. For that reason, I tabled the new clause to ensure that we get clarification on the record, and I look forward to hearing what the Minister has to say.

Photo of Sheila Gilmore Sheila Gilmore Labour, Edinburgh East 3:15, 14 July 2011

I will not take up the Committee’s time by repeating the excellent presentation of the clause made by my hon. Friend the Member for Kilmarnock and Loudoun—she made the case extremely well. In recent years, pension schemes have become highly important players in the financial market. They are important for  the stability of parts of our economy, and for those individuals who come to depend on the outcome of investments for their future. Anyone who is a member of a pension scheme is reliant on the good and forward thinking of those who are trustees of those schemes. People often assume that things will go well and that there will be no problems because it is such a basic issue. Obviously, at times there have been difficulties with unwise investments, or investments that people—both members of a pension scheme and people in the wider society who are not members of a scheme—might feel was undesirable. A lot of pension scheme members would be concerned to find out that their scheme was investing in some questionable activities, both because of the risk to their investment and because they want to feel that investments are being made responsibly in a broader sense. There are some big campaigning issues at the moment, and people talk about things such as tar sands investment, which a lot of people think is environmental vandalism in certain countries of the world. It would be desirable to feel that one’s pension fund trustees were taking such matters into account.

As my hon. Friend said, there is no reason to suppose that by taking such matters fully into account, a worse outcome will necessarily be produced. In some cases it might take slightly longer, but people will still get the returns they need with less risk and—hopefully—a more ethical view of how investments are carried out. That can be only to the good of us all.

Photo of Rachel Reeves Rachel Reeves Shadow Minister (Work and Pensions)

I start by thanking my hon. Friends the Members for Kilmarnock and Loudoun and for Edinburgh East for tabling the new clause, but I will not rehearse their comments as I entirely agree with them. I want to talk about another aspect that has been touched on rather less—that of long-term value rather than short-term reward, and the role of pension funds and the importance of fiduciary duty in terms of creating that long-term value. I shall then refer briefly to how NEST, in particular, has risen to the challenge of being a good fiduciary and of designing products that match the concerns of consumers. On governance, we all agree that part of the cause of the financial crisis was seeking short-term profit rather than long-term value in financial services; looking to the next quarterly return and trying to please the City with great profit numbers, even if those profits were superficial in their nature and turned out to be huge losses, which were picked up by the taxpayer.

The pension fund sector has a big role to play in restoring trust, and bringing to our financial markets a greater long-term perspective rather than a short-term, profit-seeking element, which has been the cause of at least some part of the financial crisis from which we are still recovering. There is also the broader issue of trust that does not relate just to the financial crisis. Clearly, the financial crisis has created a huge deficit in the trust that people put in financial markets, banks and financial institutions, and I include pensions in that group, too. But the erosion of trust did not start with the financial crisis, particularly in pensions. I draw attention to past pension crises, whether with the other media tycoon, Maxwell, or Equitable Life.

Photo of Marcus Jones Marcus Jones Conservative, Nuneaton

The hon. Lady talks about the erosion of the public’s trust in pensions. Does she agree that one of the biggest erosions of the public’s trust in pension  provision was when the right hon. Member for Kirkcaldy and Cowdenbeath raided people’s pension funds by taxing them so aggressively?

Photo of Rachel Reeves Rachel Reeves Shadow Minister (Work and Pensions)

The new clause is about the ethnical, social and governance way in which pension funds are managed, so the hon. Gentleman’s question is not particularly relevant. However, he will know that his Government do not have proposals to reinstate tax relief on dividends. If we can end this day by having a thoughtful debate, we could contribute something—

Photo of Rachel Reeves Rachel Reeves Shadow Minister (Work and Pensions)

I want to give way to as many members of the Committee as possible, but in the spirit of the amendment, I want a debate that is specifically about ESG issues. It is fitting that we give due consideration to them.

Photo of Marcus Jones Marcus Jones Conservative, Nuneaton

I was saying in relation to the new clause that the more we tax pensions, make it difficult for people to build up good pension pots and make it difficult for pension funds, surely the more that they will take high-level, short-term risks, as the Opposition have mentioned, to maximise the pension funds for the investors for whom they work.

Photo of Rachel Reeves Rachel Reeves Shadow Minister (Work and Pensions)

I am sure that the hon. Gentleman has read new clause 12 and will know that it centres on the way in which pension funds are governed and the steps taken to exercise their fiduciary duty. The Government are not planning to reverse the changes to the way in which pension dividends are taxed. He will have seen the answer to a parliamentary question that I asked of the Treasury about tax relief on pensions and will know that two thirds of it go to top tax rate payers, and that overall it is worth about £20 billion a year. Pensions are still subject to generous treatment under the tax system.

I want to focus specifically on the fiduciary duties of our pension funds and how they can be better exercised in the interests of both the pensions industry and the people saving for pensions. It is in the wider interest of the economy to rebuild the trust that has been eroded because of the mis-selling scandals that I have mentioned and the financial crisis that we are still recovering from. A key part of rebuilding the economy involves looking at the role that financial services play in the economy, whether it is the banks that have been nationalised or part-nationalised, or whether it is the pension funds that play such a huge role in investing our money on our behalf. If we are to avoid a financial crisis occurring again, we need to think hard about the role of the financial services in supporting the wider economy, and corporate governance is key to that.

We have all seen the figures showing that £1 in every £7 or £8 invested in the UK stock market is invested via our pension funds. We can see from those figures the leverage that our money in our pension funds has. If that power is exercised, the pension funds and we as contributors could make a huge difference and reward long-term value rather than short-term profit-seeking, which turns out to be anything other than profit in the long run, as we have seen in the crisis.

The issue of fiduciary duty is key. My hon. Friends for Kilmarnock and Loudoun and for Edinburgh East mentioned the exercise of fiduciary duty. The FairPensions report states that there is a myth among trustees

“of a single…‘fiduciary duty to maximise returns’”.

That is often interpreted narrowly as short-term out-performance of the market. FairPensions and many of us recognise that that is not what fiduciary duty means. FairPensions goes on to say that in its experience this can make trustees afraid or unwilling to consider wider or longer-term factors such as climate change. That is in the context of what I am saying about the long-term factors of systemic financial risk.

I do not think that fiduciary duty is wrong. Fiduciary duty is the right thing, which we need. It is how it is interpreted by pension fund trustees that is the issue. The Minister’s reflections on what fiduciary duty means in relation to pension trustees would be valuable in terms of setting the record straight and perhaps giving guidance and clarity to trustees who make such important decisions on our behalf. They have the power in financial markets to make a difference for good and to change the way that financial markets reward success.

I said that I also want to touch on NEST and how it is approaching the issue of fiduciary duty. Research by NEST was mentioned earlier by the Minister in relation to automatic enrolment. NEST’s research on its target market shows that financial return is not the only interest of potential members of NEST, who have demonstrated a clear preference for financial protection and security above potential returns. So I come back to the issue of what fiduciary duty is. It is not simply about maximising short-term return but about ensuring financial protection, particularly for the people who have that as a higher stated preference. The risk and the return are more finely balanced for many people, including the people whom NEST regards as its target market. Above the returns for more risky investments, many of the client group that NEST is hoping to attract are looking for that protection and security. Hence, the portfolio allocations in the NEST default fund are designed to meet the requirements of that target market.

NEST research also shows a substantial demand for ethical investment decisions, of the sort mentioned by my hon. Friends the Members for Kilmarnock and Loudoun and for Edinburgh East. Such research means that NEST has signed up to the UN principles for responsible investment, and we all welcome that decision. Its stance on the issue is to be applauded and will, ultimately, drive up standards throughout the industry, in terms of the types of investments made by other pension funds. The new clause would provide similarly for pension trusts and clarify the duties on trustees of schemes. It is important to have this discussion and to get the Minister’s response because I know, from the Adjournment debate in December, that he feels strongly about the issue, so putting it on the record again is useful.

The new clause would ensure that pension fund trustees take into account the environmental, social and governance issues that are relevant to the long-term health of a pension fund, which is what is important in the context of the fiduciary duty of pension trustees—much more so than for speculative investments with shorter-term outlooks than a pension fund usually has. Those environmental and social considerations are undoubtedly  relevant to the long-term interests of savers, and my hon. Friends mentioned examples such as the tar sands. Clearly, a pension fund trustee must think about the long-term viability and coherence of business strategies when investing, much more so than when only seeking short-term returns. Again, it is important that the fiduciary duty of pension fund trustees is interpreted with the long-term interests of the people contributing in mind.

I am grateful to my hon. Friends for tabling the new clause, and I look forward to hearing the Minister’s response, because I know the subject is one he cares about and wants to see dealt with better.

Photo of Steve Webb Steve Webb The Minister of State, Department for Work and Pensions

I very much want to respond in the spirit in which the new clause was tabled and in which other hon. Members have spoken. I welcome the opportunity to discuss the issues again, and to put some comments on the record.

I was slightly horrified when the hon. Lady said that what Ministers say in Committee is given a certain amount of weight, given everything I have said in the past four days, but we will give it a go. I want to say carefully and specifically, on the record, that we as a Government are very sympathetic to many of her arguments, that we fully support the highest standards of corporate governance and ethical behaviour, and that we agree that a socially responsible investment strategy is a sound choice for pension schemes. I am happy to put that on the record and, indeed, to go slightly further—making some in the room a bit more nervous perhaps—and to state categorically that it is not the duty of trustees simply to maximise short-term returns. That is not what fiduciary duty means. She is quite right that that can be the danger.

It is important to flag the many players in this space. Trustees are very important, but we also have employers, fund managers and advisers. The danger is that if we focus on one bit of the jigsaw, we will miss where the real action is. For example, for fund managers who live or die by their performance in the league table, me standing in this room on a Thursday afternoon and saying, “You don’t have to worry about all these short-term returns,” will only have them replying, “Yes, well, that’s for the birds—we’ll lose business if we don’t maximise short-term returns.” So we need to provide systematically for the entire chain—trustees, schemes, investment managers and corporate behaviour. One of the paradoxes is that the people who own the shares and could in theory cast the votes at annual general meetings and so on are often several steps removed from the beneficiaries of the pension fund, for example. A lot of interconnections make getting to the right people quite a challenge.

I accept that the amendment was probing, but one of our reservations would be that it would only apply to occupational pension funds—which is what the Bill is about—and not to other sorts of investors, such as insurance companies that provide pensions, which could create an unevenness. The hon. Member for Leeds West might argue that that is not to the detriment of those included, but we want to take an holistic approach. The Department for Business, Innovation and Skills has set up a review under John Kay, who, if I remember correctly, is the founder and director of the Institute for Fiscal Studies. His review of equity markets and long-term decision making—we have talked about short-termism—is due to publish its findings in summer 2012, and it will  specifically consider the issues of investment governance raised by the new clause. I would rather not prejudge the findings of that review, and I will be careful that any solutions that we find do not put conditions that are not imposed on other investment vehicles on pension schemes. However, we will work closely with BIS to support the review, and we will want to consider the issues again once its recommendations are known.

Hon. Members have mentioned the work of FairPensions. I think that I am on record for paying tribute to its work, which goes beyond the fairly simplistic notions of ethical investment—we can all remember from decades gone by the boycotting of South Africa—to a sophisticated assessment of the notion of fiduciary duty, what it does and does not mean, and why taking a broader approach may be in a scheme’s interest. I take that point, and we have invited one of the leading members of FairPensions to attend our departmental trustees’ meetings. I meet pension fund trustees regularly, and we have invited FairPensions to be represented in an individual capacity at those meetings to ensure that when we talk to pension fund trustees, we have that perspective in the room. I hope that will be seen as a positive action. Also, both the hon. Member for Leeds West and I attended the launch of the newly founded all-party group on socially responsible investment in the House, which was technically the second launch of the report that we have been talking about. I am happy to continue engaging FairPensions and hon. Members on the important issues.

I echo the comments made by the hon. Member for Leeds West on the role of NEST. We have heard in our debates a number of examples of the way in which NEST is a leader of innovation in its general approach to investment. I welcome its signing up to the UN principles and the specific offer of an ethical investment fund. Although “ethical investment” and “long-termism” are not the same thing, they are clearly connected. It will be interesting to see how far people, when they sign up with NEST, actively opt for the specifically ethical options. I hope that will raise the bar, because people who are competing with NEST will have to say, “Maybe we have to offer that sort of thing.” A general raising of standards in the area would be valuable.

The hon. Lady talked about recent trends in the financial markets. Some of the issues that we are talking about predate the crash. The example of tar sands and BP bring them to the fore. As she says, BP was, if I remember correctly, the biggest dividend payer into pension funds. It shows that when things go wrong, there can be a big impact on pension funds. Therefore, a trustee looking at their fiduciary duty will be absolutely right to look at the companies that they are investing in and the companies’ environmental, social and governance practices, and to ask searching questions.

We want to see people who own British industry, in many cases indirectly, exercise control and influence. It is a paradox. Many of those who indirectly own such companies would want to see them acting with more environmental awareness or become more ethically attractive. Yet, somehow their voices are never heard when the companies make their decisions. They are important ongoing issues. I think the previous Government would accept that they had reached the end of the road on considering such issues, but we certainly think there is more to be done. That is why we look forward to the  results of the Kay review, and why I certainly will continue to have an active dialogue with FairPensions and all those concerned with making sure that pensions are a force for good, not just for the their individual members, but for the wider society. While I do not think that the new clause will be helpful, because it singles out one particular bit of the market, I welcome the chance to debate the issues, and I thank the hon. Member for Kilmarnock and Loudoun for putting it on our agenda today.

Photo of Cathy Jamieson Cathy Jamieson Labour, Kilmarnock and Loudoun

I thank my hon. Friend the Member for Edinburgh East, my hon. Friend the shadow Minister and the Minister for their contributions to this debate. I have listened carefully to what the Minister said. I thank him and—this might be one of the few occasions—agree with much of what he has said. It is useful to hear that the review will report in the not-too-distant future, about a year from now. That gives us the opportunity to continue to press the case where necessary, and I am sure that hon. Members will do so.

It is also important to have on record the Minister’s words in relation to the duties. I hope that people out there will read the record if there is any dubiety and take from it what they need to do the right thing, which is essentially what we are discussing. The hon. Members who have spoken have identified the feelings of pension fund members. They often feel somewhat detached and as though their views and interests are not necessarily being represented as they would wish. In the aftermath of the financial crisis, I think that many more people are now seeking not only responsible and ethical investments but also a greater say in the process. I therefore welcome the Minister’s words and will not seek to press the new clause to a vote. I beg to ask leave to withdraw the motion.

Clause, by leave, withdrawn.