The Financial Markets Law Committee (FMLC) has published a report on pension scheme trustees’ evolving fiduciary duties and decision making in relation to climate change.

It noted that setting investment strategies and policies, and making investment decisions, in the context of sustainability and climate change had become more challenging for trustees.

In turn, this has given rise to “renewed uncertainty” around trustees’ fiduciary duties in this context, the FMLC stated, with its report therefore aiming to explain the legal position of trustees and the uncertainties that exist.

The paper argued that trustees should not leave the relevance of climate change to what is required by current legislation and regulation, as that approach would not address all the risks.

While the overall direction of change will likely be away from activity that could have adverse climate change consequences, material developments “may sometimes be sudden” or without alignment to existing strategies, the FMLC noted.

Therefore, financial factors need to be considered at several levels: At the level of a specific asset or investment, at a portfolio level, and at the level of whole economies material to the pension scheme.

While trustees do not need to become experts in the science of climate change, the responses of government, businesses and the public were relevant, and ensuring an open dialogue between trustees and their investment managers and advisers was “essential”.

The report said that what might have been previously regarded as non-financial returns or risks now need to be recognised as, or as relevant to, financial returns or risks.

Furthermore, it may be necessary to consider whether short-term gains should be rejected if they create risks to the longer-term sustainability of investment returns.

While some wider economic or systemic climate change-related issues may have been characterised as ‘too remote and insubstantial’ previously, pension fund trustees were urged to reappraise this in a context where, for example, physical, transition and litigation risks are now apparent and material.

Trustees were also warned that, as climate change-related risks are systemic, it was unlikely that portfolio diversification alone would be enough to avoid all the risks.

“The risks and uncertainty for pension fund trustees may be less if an investment strategy looks for investees who approach, or would as a result of investment approach, sustainability and the subject of climate change in a manner that supported the approach of the pension fund,” the FMLC stated.

Trustees were encouraged not to fear liability if they approach a decision properly and with due diligence.

While it was a “significant task” to identify and account for all relevant matters, this will be assisted by advisers and investment managers, the FMLC said.

The FMLC urged trustees to situate their scheme within the wider economy when constructing strategies, principles, and policies, as, in doing so, sustainability and climate change can be considered when seeking to achieve the purpose of the scheme.

Trustees may need to consider further what they require from advisers and investment managers, the report continued, to do their job effectively, and should seek out contemporary thinking to understand the continually developing investment and market landscape.

“Pension fund trustees can properly take steps to guard against the risk of focusing so much on one matter they fail to give due consideration to other relevant matters,” the FMLC said.

The report continued: “The weight to be given to different matters is an important part of the process of reaching a decision in the circumstances of the case.

“It is relevant and appropriate for pension fund trustees to consider what would beneficiaries as a body ask and want to know before a decision is made or about a decision made.

“In law, the exercise of judgment is permissible (indeed, necessary) for pension fund trustees when making decisions. The judgment will usually be informed and assisted by advice, but the judgment is that of the pension fund trustees. The reasons for it should be capable of being explained.

“For all the views or advice available, there is no one else, other than the pension fund trustees, with the authority to bring human judgment into the key decisions that will need to be made by a pension scheme.

“The fiduciary duties of the pension fund trustees focus that judgment on the purpose of the scheme and on the interests (under the scheme’s trust) of its beneficiaries. Without that judgment, an important part of the checks and balances that are needed are unavailable to the scheme.”

The report noted that if pension trustees approached their fiduciary duties in the context of sustainability and climate change, and with advice and assistance, their approach can be expected to inform how investees measure success, and identify, address, and monitor risk and return.

It concluded that trustees are generally supported by contributions from advisers and investment managers, and in circumstances where the combination of contributions are fully recognised and well delivered, beneficiaries will be even better served.

Commenting on the report, IFM Investors global head of sustainable investment and FMLC working group member, Maria Nazarova-Doyle, said: “The clarification of fiduciary duty and its compatibility with climate change and sustainability matters by FMLC can have long-reaching positive impact not just in the pensions industry, but in the real economy as well.

“Asserting trustees’ duty to take account of climate change and other relevant sustainability factors as financially material, recommending narrative strategy analysis to supplement the traditional quantitative models given the complexity of such systemic issues, and confirming trustees’ reinforcing role in positive improvements in businesses they invest in via stewardship are just some of the highlights of this groundbreaking review.

“I believe this paper makes an incredibly important contribution to this ongoing debate.”

LCP head of responsible investment, Claire Jones, added: “We welcome the FMLC’s clear and practical summary of the latest legal thinking on trustee decision making in the context of climate change.

"It should go a long way towards clearing up the uncertainty which has hindered this complex topic. We hope the Department for Work and Pensions and The Pensions Regulator will throw their weight behind it.

“The FMLC has highlighted a wide range of factors that are potentially relevant to trustees’ investment decisions, going far beyond those which have traditionally been considered. All trustees should read the paper and actively consider climate change when making decisions in future, not just rely on advisers and investment managers to have done that for them.

“LCP CEO, Aaron Punwani, has recently called for major shift in trustee thinking when making investment decisions.

"This would involve having a time horizon which extends well beyond immediate transactions such as buyout, and would mean trustees using their power as large-scale asset owners to influence governments to do more to prevent and mitigate the effects of climate change. This report could prove to be the catalyst for such a shift.”

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