UK Fiduciary Duty Review Puts Doubts to Bed

Climate and other sustainability-linked themes are integral to pension trustees’ investment decisions, the FMLC has determined. 

A new review of pension trustees’ fiduciary duties and the extent to which they can account for climate and sustainability themes has “broadened the frame” and provided much-needed clarity, industry experts have said. 

The review was promised by the UK government as part of its Green Finance Strategy in 2023 and has been carried out by the Financial Markets and Law Committee (FMLC) – an independent body seeking to reduce legal uncertainty in financial markets.  

The paper states that approaching climate and other sustainability matters through a financial perspective, and incorporating them into investment decision-making, is consistent with trustees’ fiduciary duties. It also mentions that Sustainability is “integral” to the decision-making process of pension trustees. 

“The committee has really broadened the frame and encourages pension trustees to think about how climate change and sustainability risks can impact their portfolios over different time horizons,” Tom Gosling, Executive Fellow at the London Business School, told ESG Investor. “But it’s not going to turn pension funds into climate activists. Trustees now need to think about the nature of these issues and the extent to which they want to address them.” 

Widened horizons 

Although the paper is predominantly focused on climate change, its findings may be extended to other sustainability themes, such as nature. Investments of all kinds are increasingly subject to sustainability-linked risks, the FMLC stressed, referring to the rise of litigation in connection with businesses and governments’ response to climate change. 

However, pension trustees should not simply base the relevance of climate change to their investments on current legislation and regulation, as this approach would not sufficiently address the systemic nature of climate-related impacts. 

Trustees should instead consider the potential financial impacts of climate change at the asset, portfolio and whole-economy levels, the paper states. Although issues like climate change remain complex, sustainability themes may develop and deepen pension trustees’ appreciation of what represents return and risk, as well as the importance of time horizons. 

“The FMLC has put to bed any lingering doubt as to whether addressing sustainability issues, and in particular climate change, is consistent with fiduciary duties,” said Will Martindale, Co-founder of investment consultancy Canbury. “It is.” 

Martindale also welcomed the paper’s suggestion that short-term financial gains should be rejected in incidences where they may create longer-term sustainability-related risks. 

“It states that diversification alone is unlikely to be enough to avoid systemic risks such as climate change,” he added. “The paper is essential reading – not just for pension fund trustees, but their advisers and asset managers.” 

In addition, the review emphasised that pension advisers and investment managers alike may play an important role in identifying and accounting for exposures to climate and sustainability-related risk. As such, the FMLC encouraged trustees to consider what they require from them to support them in the delivery of their fiduciary duties. 

Crystal clear 

The FMLC review also built on 2014 and 2017 reports on fiduciary duty published by the UK’s Law Commission.  

While the 2014 report distinguished between trustees’ ability to take financial and non-financial factors into account when making investment decisions, the 2017 report recommended that existing legislation be amended to require pension trustees to evaluate long-term risks to their investments – including those relating to sustainability. 

Rather than changing any of the fundamental guidance provided by these two reports, the FMLC is clarifying it, Gosling argued. 

“The FMLC is encouraging trustees to step up and take a more expansive view of their responsibilities relating to climate, while fairly reminding them that this has to be done rigorously and within the framework of their responsibilities,” he said.  

But for to Paul Lee, Head of Stewardship and Sustainable Investment Strategy at investment consultancy Redington – who took part in the working group for the review – the FMLC’s approach goes further. 

“The new paper takes a major step towards removing much of the uncertainty that exists, making clear that trustees can – and perhaps, should – incorporate climate change and broader sustainability issues into their investment decision-making,” he said. “That’s a real shift in understanding, which ought to enable more trustees to feel empowered to incorporate [these elements] into their investment decision-making.”

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