Squaring the circle of sustainable investing with pension trustee’s fiduciary duties

On 6 February 2024 the Financial Markets Law Committee published its paper, Pension Fund Trustees and Fiduciary Duties: Decision making in the context of Sustainability and Climate Change. The paper offers much needed clarity in an area of misunderstanding. By expressly stating that sustainability should be viewed as a financial factor rather than a non-financial factor, the paper should give trustees of all pension schemes the confidence and backing they need to take account of climate change risk when making investment decisions. Not least because it has been suggested to the Work and Pensions Committee that the paper could be adopted by the Pensions Regulator as guidance for trustees.

It provides pension trustees with a general explanation of the law before offering suggestions as to how, in practice, pension trustees can, in the context of sustainability and climate change, take investment decisions that are consistent with their fiduciary duty to promote the proper purpose of the scheme and to act in the interests of the scheme’s beneficiaries. 

Trustees’ legal duties

The law requires trustees to reach careful decisions. They must take into account all relevant matters and not take into account irrelevant matters. However, provided trustees approach a decision properly, for a proper purpose, act within their powers, give a decision due consideration and do not fail to make decisions when they should, they should successfully defend a claim for breach of trust.

Overall, the fiduciary duties of pension trustees support taking a broad perspective and a long-term outlook. The law recognises that there may be a range of appropriate decisions. 

Trustees’ decisions are judged by reference to circumstances at the time the decision was made and not with the benefit of hindsight. Furthermore, being subject to a fiduciary duty does not require trustees to exercise undue caution – indeed, the paper states that “too little or too much caution is not in line with responsibility “for the conduct of the affairs of another” where those affairs are financial”. 

Applying the law in practice

The paper recognises it is easier to state pension trustees’ duties than it is to apply them. It, therefore, sets out some considerations for trustees when taking sustainability into account in their investment decision-making. 

• Irrespective of legal and regulatory changes, climate change (including actual or perceived threats of failure from climate change) affects the consideration of risk and return. Given this, the paper states it is hard to see how trustees, advisers or investment managers could reasonably exclude uncertainty about climate change and its causes and consequences as a relevant financial matter to be taken into account. 
   
• Despite the approach taken by the Department of Work and Pensions in the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021, approaching an investment decision with regard to financial factors doesn’t mean it must be made by pointing to a metric or financial projection. The report states that “Sometimes financial factors cannot be quantified but it does not follow that they lack weight.”  Further, “Rigorous qualitative and not simply quantitative consideration is now more important in the pension sector.”
   
• Knowledge and understanding of investments and markets is continually developing – trustees should seek advice to ensure they are up to date with current thinking. Trustees should understand the scope of such advice and the assumptions on which it has been prepared before making investment decisions. They should be prepared to question advice and be mindful of situations where investment managers and advisers may not have the skills or knowledge to provide them with clear information and definitive advice. 
   
• It is relevant and appropriate for trustees to consider what a scheme’s beneficiaries would want to know about a potential investment. However, the decision itself and responsibility for it remains with the trustees. 

Where this leaves trustees

The paper squares the circle created by the Law Commission in its reports of 30 June 2014  and  22 June 2017 when it drew a distinction between “financial” and “non-financial” factors, with the former being categorised as “any factors which are relevant to pension fund trustees’ primary investment duty of balancing returns against risks”. 

However, questions amongst lawyers as to whether the Law Commission was correct regarding when non-financial factors may be taken into account, the High Court’s decision in McGaughey v Universities Superannuation Scheme Limited and uncertainty as to whether climate-related risks are a financial or non-financial factor has resulted in inertia on some trustee boards when it comes to taking account of sustainability and climate change in investment decisions. 

The paper impliedly makes the point that people have misunderstood what the Law Commission viewed as the distinguishing factor between financial and non-financial factors, which is the motivation behind the consideration of that factor as part of the decision-making.  

So, for example, not investing in meat producers because of disapproval of the relevant industry would amount to a non-financial factor; not investing in meat producers because of concerns that the trend towards vegetarianism / veganism will result in a reduction in profitability constitutes a financial factor. 

Secondly, trustees and advisers may not have appreciated the breadth of scope of “financial” factors and have therefore incorrectly construed the Law Commission’s analysis and consequently disregarded matters which they could, and arguably should, have taken into account. 

By expressly stating that sustainability should be viewed as a financial factor rather than a non-financial factor, the paper should give trustees of all pension schemes the confidence and backing they need to take account of climate change risk when making investment decisions.