103
Sustainable Investing by
Occupational Pension Scheme
Trustees: Reframing the
Fiduciary Duty
Andy Lewis*
Introduction
A variety of legislative, policy, scientifi c, commercial and stakeholder infl uences prompt
occupational pension scheme trustees to factor environmental, social and governance (ESG)
risks and opportunities, and potentially wider sustainability considerations such as impact, into
their investment decisions. However, a trustee’s ability to do this in practice typically depends
on a close interaction between two major issues. The fi rst is the investment reality: the extent
to which sustainability considerations are expected to affect investment risk, opportunity
and strategy. The second issue is the law around trustee investment decision-making, and
specifi cally the extent to which the law permits sustainability considerations to be taken into
account in trustee investment decisions.
Where the views on these two issues are aligned, trustees are more likely to be able to get
comfortable in justifying investment decisions that factor in sustainability considerations, such
as adopting net zero targets or allocating assets to ESG or impact funds. There are examples of
schemes having taken such decisions in the real world today.
1
By contrast where views are not
aligned, such decisions can become diffi cult or impossible to support.
In that context, it is signifi cant that there remains something of a vexed question around
the extent to which sustainability considerations are compatible with the trustee fi duciary duty
when investing. A recent survey reported in Professional Pensions revealed mixed views about
whether ESG ‘compromises’ the fi duciary duty.
2
In its response to a government consultation
on climate change and stewardship disclosures, the Impact Investing Institute expressed
‘signifi cant ongoing concern about misconceptions and misapplications of the fi duciary duty,
* Partner and solicitor, Travers Smith LLP. The author is grateful to Alex Economides, Jonathan Gilmour, Danny
McNeill, David Pollard and Harriet Sayer for their comments. Responsibility for errors is mine alone.
1 For example, the largest private-sector pension scheme in the UK, the BT Pension Scheme, adopted a net zero target
in 2020.
2 William-Smith, H, ‘Compromising on fi duciary duty? Your thoughts on ESG’, Professional Pensions, 8 June
2022, www.professionalpensions.com/news/4050905/compromising-fi duciary-duty-esg, accessed 21 September
2022. See also Westley, A, ‘The S Factor: a challenge to fi duciary duty’, Professional Pensions 17 May 2022, www.
professionalpensions.com/opinion/4049836/%E2%80%98%E2%80%99-factor-challenge-fi duciary-duty, accessed
21 September 2022, in which the author observes: ‘Time and again, trustees cite their fi duciary duty as a reason for
hesitancy in engaging with ESG in scheme investments.’
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with the result that sustainable investment practices are not being effectively cultivated.’
3
In this author’s practice, this is often described to him as ‘uncertainty’ about the fi duciary duty.
This article seeks to explore the sources of uncertainty within the current orthodox legal
interpretation of the fi duciary duty in the occupational pensions context. It then attempts
to outline a reframed understanding of the fi duciary duty which may help to address those
uncertainties.
This article therefore focuses on the case law and well-known Law Commission analysis
of the fi duciary duty. Save for a minor digression later in the discussion, it does not cover the
other signifi cant sources of occupational pension scheme investment duties, ie the provisions of
the scheme’s governing trust deed and rules, and primary and secondary legislation.
Law Commission model
A useful starting point is provided by two landmark Law Commission reports: ‘The Fiduciary
Duties of Investment Intermediaries’ (LC2014)
4
and ‘Pension Funds and Social Investment’
(LC2017).
5
It should be noted that the Law Commission’s ability to give defi nitive statements of
the law has been questioned.
6
The Law Commission itself also made clear that its remit in this
area was to evaluate the state of the law, make recommendations for possible action by other
authorities and ‘explain the nature of fi duciary and other duties to act in the best interests of
savers’.
7
Despite these limitations, the author’s experience is that the conceptual model of the
fi duciary duty developed by the Law Commission in its two reports has been, and continues to
be, infl uential in shaping legal, regulatory and industry thinking notwithstanding developments
in the case law and investment practice since LC2014.
8
It therefore makes sense for a discussion
of the law in this area to engage with the Law Commission model.
In a key passage from LC2014, the Law Commission summarises the basic position as
follows:
The primary concern of trustees must be to generate risk-adjusted returns. In doing so,
they should take into account factors which are fi nancially material to the performance
of an investment. These may include environmental, social and governance factors. It is
for trustees, acting on proper advice, to evaluate and weigh these risks.
3 ‘The Impact Investing Institute’s response to the Department for Work and Pensions Consultation: Climate and
investment reporting: setting expectations and empowering savers’, 6 January 2022, www.impactinvest.org.uk/
wp-content/uploads/2022/01/DWP-Consultation-Response-.pdf, accessed 21 September 2022.
4 https://s3-eu-west-2.amazonaws.com/lawcom-prod-storage-11jsxou24uy7q/uploads/2015/03/lc350_fi duciary_
duties.pdf, accessed 21 September 2022.
5 https://s3-eu-west-2.amazonaws.com/lawcom-prod-storage-11jsxou24uy7q/uploads/2017/06/Final-report-
Pension-funds-and-socia....pdf, accessed 21 September 2022.
6 Daykin, S, ‘Pension scheme investment: is it always just about the money? To what extent can or should trustees take
account of ethical or ESG factors when investing?’ (2014) 28(4) TLI 165 at 189.
7 LC2014, p 9.
8 For examples of the infl uence of LC2014, see Palestine Solidarity Campaign v Secretary of State for Housing, Communities and
Local Government [2020] UKSC 16, reg 2(3)(b)(vi)–(vii) of the Occupational Pension Schemes (Investment) Regulations
2005 (SI 2005/3378), the Impact Investing Institute, ‘Impacting investing by pension funds: fi duciary duty – the legal
context’ (November 2020): www.impactinvest.org.uk/wp-content/uploads/2020/11/Impact-investing-by-pension-
funds-Fiduciary-duty-%E2%80%93-the-legal-context.pdf accessed 21 September 2022, and ‘Investing to fund DB’
in the Pensions Regulator’s DB Investment Guidance: www.thepensionsregulator.gov.uk/en/document-library/
scheme-management-detailed-guidance/funding-and-investment-detailed-guidance/db-investment/investing-to-
fund-db#:~:text=While%20non%2Dfinancial%20factors%20are,share%20a%20particular%20view%2C%20and,
accessed 21 September 2022.
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However, the law is fl exible enough to accommodate other concerns. Trustees may
take account of non-fi nancial factors if they have a good reason to think that the scheme
members share a particular view, and their decision does not risk signifi cant fi nancial
detriment to the fund.
9
Thus, in broad terms, the Law Commission recognises two categories of factor that may
infl uence trustees when exercising the power of investment:
(a) ‘non-fi nancial factors’; and
(b) ‘fi nancial’ (or ‘fi nancially material’) factors.
These categories will be considered in turn. As will be seen, sustainability considerations can
potentially fall into either category.
Non-fi nancial factors
Defi nition and scope
Non-fi nancial factors are defi ned as ‘factors which might infl uence investment decisions
motivated by other (non-fi nancial) concerns, such as improving members’ quality of life or
showing disapproval of certain industries.’ So, non-fi nancial factors are drivers of investment
decisions that are not motivated by what might be called conventional investment concerns,
such as risk/return.
Against that backdrop, the Law Commission concluded that trustees may take non-
fi nancial factors into account subject to two threshold tests:
(a) trustees should have good reason to think that scheme members would share the concern;
and
(b) the decision should not involve a risk of signifi cant fi nancial detriment to the fund.
10
The Law Commission also said that, whilst trustees can consider issues in the round when
deciding whether or not the two threshold tests are met, both tests need to be met in order for
an investment decision to be made on non-fi nancial grounds.
11
For occupational pension scheme trustees, the non-fi nancial factors category gives rise to
a number of potential issues.
Legal uncertainty
First, there remains a very real question about whether the non-fi nancial factors category is a
correct statement of the law in the occupational pension scheme context.
12
This assertion is
perhaps surprising: after all, the non-fi nancial factors category has now received specifi c judicial
recognition.
9 LC2014, p 127.
10 Save where the investment is specifi cally authorised by the fund’s trust deed or is a defi ned contribution self-select
fund – Ibid, pp 113–114.
11 Ibid, p 123.
12 See Daykin, S (above n 6), pp 179–180.
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In Palestine Solidarity Campaign v Secretary of State for Housing, Communities and Local
Government, Lord Carnwath observed: ‘There appears now to be general acceptance that the
criteria proposed by the Law Commission are lawful and appropriate.’
13
This seems to be
a clear endorsement. Moreover, on its face Palestine Solidarity is a case about pension fund
investment: the underlying practical issue in the case was, in effect, a disagreement about
whether the scheme should adopt ethical investment criteria to screen against certain Israeli-
related investments (a policy which the Palestine Solidarity group supported). So where is the
issue from an occupational pensions perspective?
To begin with, the schemes concerned in the Palestine Solidarity case were not private
sector occupational pension trusts: they were public sector schemes constituted under secondary
legislation and subject to a separate (albeit similar) set of investment duties. More importantly,
however, in substance Palestine Solidarity was not a decision about the basic investment duties
at all. It was a judicial review of the scope of the Secretary of State’s statutory power to
issue investment guidance to the relevant public sector schemes. The guidance issued by the
Secretary of State appeared to be largely based on the Law Commission’s model for describing
the investment duties, including by reference to non-fi nancial factors, but the central issue in
the proceedings was that it sought to prohibit the relevant public sector schemes from adopting
investment policies that were contrary to UK foreign or defence policy. Since regulations
required the public sector scheme to construct its investment strategy in accordance with the
guidance, the practical effect of the revised guidance would have been to prevent the schemes
from applying their proposed ethical investment criterion (based on non-fi nancial factors) to
screen against the relevant Israeli-related investments. The immediate question before the
Supreme Court was not, therefore, what the fundamental scope of the investment duty was,
but rather whether the Secretary of State had exceeded their statutory powers in issuing the
guidance on the specifi c terms that they did. The Supreme Court decided that the relevant
guidance was ultra vires the statute.
Viewing the judgment in that way, Lord Carnwath’s observations about the Law
Commission’s non-fi nancial factors test were obiter. The same can be said about the references to
non-fi nancial factors in the judgments of Lord Wilson (agreed by Lady Hale) and the dissenting
judgment of Lady Arden and Lord Sales.
14
Thus, it is suggested, Palestine Solidarity does not in
fact move the non-fi nancial factors debate materially further forward for occupational pension
schemes.
The question arose again more recently in Butler-Sloss & ors v the Charity Commission
of England and Wales & anor.
15
In this case, Michael Green J considered proposed trustee
investment policies motivated by climate change concerns whereby investments that were not
aligned with the 2016 Paris Agreement would be screened, even if this could produce lower
overall returns in the portfolio. The learned judge specifi cally considered the extent to which
‘non-fi nancial’ considerations, such as a principled desire to mitigate climate change, could
lawfully be taken into account when exercising these trusts’ investment powers.
16
13 Palestine Solidarity,(above n 8), at [43]. The ‘signifi cant fi nancial detriment’ limb of the non-fi nancial factors test is
described slightly differently here: it is cited as ‘not involve signifi cant risk of fi nancial detriment’. By contrast, the test
in both LC2014 and in the relevant LGPS guidance was ‘not involve a risk of signifi cant fi nancial detriment’ – this
latter formulation being derived from another leading case: Harries (Bishop of Oxford) v Church Commissioners [1993]
2 All ER 300 at [16]. The difference in language has been highlighted as a further source of uncertainty about the effect
of Palestine Solidarity, though viewed in context of the judgment as a whole, it seems more likely to the author that this
was a simple slip of the pen. See also Bennett, P, ‘Would it be a breach of a pension fund trustee’s investment duties
to invest in “green gilts”’? (2021) 35 TLI 133.
14 Harries (Bishop of Oxford) (above n 13), at [17]–[19], [24]–[27], [57], [60], [62] and [80].
15 [2022] EWHC 974 (Ch).
16 Ibid, at [78].
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However, in Butler-Sloss, the Court was looking at investment policies of charitable trusts
that had express environmental protection purposes.
17
In that context, it is perhaps easier to
see how the Court concluded that a principles-motivated net zero-aligned investment policy
would be proper. As will be seen below, occupational pension schemes do not have this
sort of express environmental protection purpose. Moreover, this case was argued against a
backdrop of specifi c guidance from the Charity Commission, and the leading case in this area,
both of which considered questions of the extent to which charities can decide to make ethical
investments.
18
Occupational pension schemes are not charitable trusts, and Michael Green J is
careful to note this distinction in his review of the leading occupational pensions investment
case:
In Cowan v Scargill [1985] 1 Ch 270, Sir Robert Megarry V-C had to consider whether
the trustees of the Mineworkers Pension Scheme, half of whom were appointed by the
National Union of Mineworkers … were acting in breach of their duties in blocking an
investment plan which included an increase in overseas investment and investments in
energy companies that were in direct competition with coal. Such investments would
be contrary to the NUM’s policy and principles. This was a trust for the provision of
fi nancial benefi ts, not for a fi nancial purpose. As such, the Vice-Chancellor held that as
this was a trust to provide fi nancial benefi ts, the power of investment must be exercised
to yield the best return for benefi ciaries.
19
We will return to Cowan v Scargill later. The key point for present purposes is that the factual
matrix in Butler-Sloss makes the case diffi cult to rely on as authority for the position in relation
to non-fi nancial factors for private sector occupational pension schemes, meaning that between
this case and Palestine Solidarity, there is still no decided authority on the position.
Practical uncertainties
Even if the legal uncertainty around non-fi nancial factors for occupational pension scheme
trustees did not exist, there are also practical uncertainties within the two threshold tests
themselves.
(a) ‘Good reason to think members would share the concern’ How should trustees properly
satisfy themselves on this point? The Law Commission comments on this in LC2014
and in accompanying guidance. On the one hand, unanimity of views is not required.
On the other, trustees should not simply impose their own ethical views. In clear-cut
cases, it may be suffi cient to assume what members believe. In others, consultation may
be appropriate.
20
This is helpful up to a point but attempts to build real-life decisions
upon this foundation soon reveal other layers of potential diffi culty. For example, is
it suffi cient only to seek the views of members as the primary benefi ciaries of the
17 Ibid, at [13]–[14].
18 Charity Commission, ‘Charities and investment matters: a guide for trustees (CC14)’, www.gov.uk/government/
publications/charities-and-investment-matters-a-guide-for-trustees-cc14, accessed 21 September 2022, and Harries
(Bishop of Oxford) v Church Commissioners [1993] are discussed at Butler-Sloss & ors v the Charity Commission of England
and Wales & anor (above n 15), [35]–[76].
19 Butler-Sloss & ors v the Charity Commission of England and Wales & anor (above n 15), at [52].
20 LC2014, pp 119–121; LC2017, pp 41–42 and Ch 9.
Trust Law International, Vol. 36, No. 3, 2022
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scheme (but not spouses or other contingent benefi ciaries)?
21
Why are the chosen non-
fi nancial concerns being prioritised over others? What level of apparent consensus is
appropriate within the particular scheme membership? Do members’ views need to be
‘fully informed’ or similar – and who is responsible for providing the information to
members if this is required? What happens if members’ views change over time or new
and more pressing non-fi nancial concerns emerge – might the investments need to be
rebalanced? How to guard against the risk of the decision being swayed one way or the
other by a vocal minority? Are trustees confi dent in communicating that there could
be some fi nancial detriment to members’ retirement benefi ts? How in practice should
trustees deal with members who feel disenfranchised? How much time and resource
should trustees properly invest in this exercise, given that there is no positive duty on
them to take non-fi nancial factors into account in the fi rst place?
(b) ‘Not involve risk of signifi cant fi nancial detriment to the fund’ What level of fi nancial detriment
to the scheme is ‘signifi cant’?
22
What is the benchmark against which the risk of fi nancial
detriment, and the acceptable (or non-signifi cant) level of potential detriment should be
assessed, especially if there is no directly comparable investment or strategy? The test seems
to require trustees to prove a negative (the absence of risk), and with a higher degree of
confi dence than is required when investing for ‘fi nancially material’ reasons.
23
There is less
guidance on these issues, beyond a clear steer for the need for professional advice and a
need to consider each issue on its merits instead of applying a blanket policy.
24
In my view,
it is highly likely to require a nuanced analysis of the scheme’s specifi c characteristics – its
benefi t structure, the overall construction of its investment strategy, its investment time
horizons and member demographics.
These practical uncertainties are not easy to resolve, and trustees would need a good evidence
trail of thoroughly considered decision-making on both points in order to give them the
greatest confi dence in their position in the event of a future challenge. There are some further
thoughts on this below but note that robust decision-making on these issues can make for
unwieldy and expensive governance, which in turn could act to discourage trustees and their
advisers from exploring the issues (on grounds of cost effectiveness if nothing else).
Conclusions on non-fi nancial factors
There are some genuine legal and practical uncertainties around the ability of occupational
pension scheme trustees to take non-fi nancial factors into account in investment decision-
making.
21 This limb of the LC2014 test was perhaps extrapolated from an aspect of Sir Robert Megarry VC’s judgment in Cowan
v Scargill [1985] Ch 270 – see [48]. For more on the position of spouses and contingent benefi ciaries, see Pollard, D,
The Law of Pension Trusts (Oxford University Press, 2013), Ch 8. Note that the test proposed in LC2014 does not
mention the views of the sponsoring employer (which effectively underwrites the investment strategy in a defi ned benefi t
scheme) – though of course trustees who are required to produce a statement of investment principles must include
within this their policy on ‘non-fi nancial matters’, and there is a requirement to consult (properly) with the employer
about the statement of investment principles: see reg 2(2)(b) of the Occupational Pension Schemes (Investment)
Regulations 2005 (SI 2005/3378) and Pitmans Trustees Ltd & ors v Telecommunications Group PLC [2004] EWHC 181
(Ch).
22 And, indeed, what precisely is the test? See n 14 above.
23 Where a trustee invests in the best fi nancial interests of benefi ciaries, ie solely on the basis of fi nancially material factors,
there seems to be no express expectation in case law that the trustee must avoid all risk of fi nancial detriment, or indeed
the risk of signifi cant fi nancial detriment, as long as the duty of care is discharged. Discussed further below.
24 LC2014, pp 121–123.
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For policymakers, private individuals, NGOs and others who are keen to see pension
scheme capital deployed in a more sustainable or positively impactful way, this uncertainty causes
a problem: it can lead to caution, even reluctance, on the part of trustees and their advisers, to
invest in ways that might be characterised as involving non-fi nancial factors. But this hesitancy
can sometimes refl ect an unspoken assumption that a sustainable or impactful investment
consideration will always fall into the non-fi nancial factors category. As demonstrated below,
this assumption is not necessarily correct.
Financially material factors
Defi nition and scope
The Law Commission’s second category of factor in trustee investment decisions is the
‘fi nancial factor’. Financial factors are defi ned variously within LC2014 as ‘factors relevant
to increasing returns or reducing risks’, or ‘any factor which is relevant to trustees’ primary
investment duty of balancing returns against risks.’
25
This choice of language is signifi cant, as
will be seen later below. For the moment, it is suffi cient to note that the category encompasses
those investment considerations that relate to the more traditional fi nancially motivated
investment drivers of risk and return – which non-fi nancial factors expressly do not.
The Law Commission also gives a brief example to illustrate how ESG or ethical
considerations might fall into the ‘fi nancial factors’ category when making investment decisions:
When investing in long-term equities, the risks will include risks to the long-term
sustainability of a company’s performance. These may arise from a wide range of factors,
including poor governance or environmental degradation, or the risks to a company’s
reputation arising from the way it treats its customers, suppliers or employees. A company
with a poor safety record, or which makes defective products, or which indulges in sharp
practices also faces possible risks of legal or regulatory action.
Often these risks will involve breaches of prevailing ethical standards. However, where
poor business ethics raise questions about a company’s long-term sustainability, we would
classify them as a fi nancial factor, rather than … a ‘purely ethical’ concern.
26
Thus, the Law Commission draws a link between an ESG or ethical issue and the impact that
issue has or may have on the fi nancial risk within a business as an investee. The Law Commission
is also at pains to point out that this does not mean that ESG or ethical considerations should
always be taken into account as fi nancial factors. Trustees have a discretion to (‘may’) take
account of fi nancial factors, but ‘should’ take into account those fi nancial factors which are
‘fi nancially material’. And whether a particular ESG or ethical consideration is fi nancially
material is a question to consider in the context of the risks of a particular investment:
It is for trustees’ discretion, acting on proper advice, to evaluate these risks. This will
include an assessment of which factors are fi nancially material and the weight they should
be given.
27
25 Ibid, p 112.
26 Ibid.
27 LC2014, p 113.
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In other words, based on the Law Commission model, ESG or ethical considerations are
in theory capable of being fi nancial factors where they have a bearing on the risk/return
characteristics of an investment. And a fi nancial factor becomes a fi nancially material factor
where the trustees, acting properly, decide that it is fi nancially material to the decision they
are making. Once this has occurred, trustees are under a positive duty to take that fi nancially
material factor into account as part of a legally proper decision-making process.
Areas of uncertainty
This apparently simple idea masks some further uncertainty. It is not the same kind of
uncertainty as that which plagues the non-fi nancial factors category (see above). Rather, it
is suggested, this type of uncertainty is uncertainty arising from how to apply the fi nancial
(fi nancially material) category within the intellectual exercise of making a trustee investment
decision.
This uncertainty of application arises primarily because it appears that the Law Commission
viewed the ‘fi nancial (fi nancially material)’ and ‘non-fi nancial’ categories as mutually exclusive:
a factor cannot not be both at the same time.
28
If a factor is fi nancial, it may be taken into
account. If it is a fi nancially material factor, it ‘should’ be taken into account. If a factor is
neither fi nancial nor fi nancially material nor passes the two-limb non-fi nancial factor test, it
is suggested that the Law Commission model expects the factor to be disregarded. Thus, the
model requires trustees to carry out a four-way categorisation exercise, drawing bright lines
between:
(a) those fi nancial factors which they have identifi ed as fi nancially material (and which they
are thus positively required to take into account);
(b) other fi nancial factors which they may take into account by exercising their discretion as
to how they construct their decision;
29
(c) non-fi nancial factors which can be taken into account because the two-stage Law
Commission test is met; and
(d) factors which cannot properly be taken into account at all.
In real life, decisions are rarely so clear-cut. Consider a snapshot review of a business with
potential issues around poor treatment of its employees. At the point of deciding whether or
not to invest, this concern might be categorised as any of a fi nancial or fi nancially material or
a non-fi nancial factor – that is, as both an investment risk of varying degrees of likelihood and
fi nancial impact (labour relations deteriorating and/or litigation or regulatory interventions
arising with an adverse effect on fi nancial performance) and/or as a concern about the societal
impact of the business (poor employment practices affecting employees’ quality of life and
the wider community). The factor might also switch categories over time – as the Law
Commission’s own example highlights, the concern might start out as a purely non-fi nancial
issue (poor business ethics) but later on crystallise an actual liability risk that clearly is fi nancially
material.
28 Ibid, p 112 – the Law Commission defi nes fi nancial factors as those relevant to increasing returns or reducing risks,
whereas non-fi nancial factors ‘are not’.
29 This does not require trustees to identify and consider every conceivable relevant factor – see below and Pollard, D,
Pensions, contracts and trusts: legal issues on decision making, (Bloomsbury Professional, 2020), Chs 48–49.
Trust Law International, Vol. 36, No. 3, 2022
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So, in reality, the borders between fi nancial, fi nancially material and non-fi nancial factors
are mutable.
To address this, the Law Commission highlights the helpfully wide discretion that the
law provides in allowing trustees to make judgment calls about what is or isn’t fi nancially
material, and how much weight to give a particular fi nancially material factor, within their
overall decision (see above). On its face this is a sound legal workaround, and we will return
to it from a slightly different perspective later. But this fl exibility can, it is suggested, lead
to diffi culty for trustees in applying the Law Commission model when taking decisions in
practice.
This is because, as was seen above, the Law Commission model requires sustainability
considerations to be categorised as ‘fi nancial’, ‘fi nancially material’, ‘non-fi nancial but valid’
or none of the foregoing. As has also been seen, whether or not a particular issue falls into the
fi nancial or fi nancially material category can be highly context-specifi c and can change from
time to time. The combined effect of (i) the existence of the four alternative but mutually
exclusive categories, and (ii) the mutability of the boundaries between them, is to contribute
further signifi cant conceptual uncertainty into an already complex decision-making process.
To be clear, this is a structural challenge within the model itself, and it is only a partial answer
to say that trustees can take advice and seek to reach the best decision they can by applying
objective criteria at the time they are making it. In the author’s experience, a more likely result
is higher levels of caution between trustees and their advisers about integrating sustainability
considerations at all. This lies at the root of what the Impact Investing Institute described as
the failure to cultivate more sustainable investment practices.
30
Others have described the
categorisation problem in even stronger terms.
31
Even if trustees are comfortable to categorise an issue as fi nancial or fi nancially material,
they have to grapple with the further problem that the issue they are looking at could play
out in complicated ways over an extended period of time and can crystallise unpredictably
within investment performance or value. This makes the investment analysis underpinning the
identifi cation and evaluation of fi nancial or fi nancially material sustainability factors extremely
complex and demanding. Trustees and their advisers need to be equipped to judge where,
when, and how they think the relevant risks may arise. Data and conceptual frameworks
are being developed that allow increasingly sophisticated analysis in this area and investment
professionals are better placed to comment on this than this author,
32
but this idea is revisited
below.
30 See n 3 above.
31 In a joint response to a Law Commission consultation on its programme of law reform, the Institute and Faculty
of Actuaries and the Investment Consultants’ Sustainability Working Group described the fi nancially material/
non-fi nancial divide as a ‘false dichotomy’. See www.actuaries.org.uk/system/fi les/fi eld/document/07-31-Law-
Commission-14th-Programme-of-Review.pdf, accessed 21 September 2022. As set out above, there are in fact three
categories of valid factor within the Law Commission model: fi nancial, fi nancially material (which is a subset of
fi nancial where a positive duty to take the factor into account applies) and non-fi nancial. While the distinction
between fi nancial and fi nancially material factors should not be ignored, in practice, it is the dichotomy between
fi nancial (fi nancially material) and non-fi nancial factors which is likely to cause the greatest diffi culty in decision-
making.
32 For example note the discussions of pension funds as universal owners or quasi-universal owners: see Urwin, R, ‘Pension
funds as universal owners: opportunity beckons and leadership calls’, Rotman International Journal of Pension Management
(2011) 4(1), pp 26–33, and the number of organisations either voluntarily or compulsorily making disclosures in line
with the recommendations of the Taskforce on Climate Related Financial Disclosures in the TCFD’s regular status
reports, 2021 here: https://assets.bbhub.io/company/sites/60/2022/03/GPP_TCFD_Status_Report_2021_Book_
v17.pdf , accessed 5 October 2022.
Trust Law International, Vol. 36, No. 3, 2022
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Returning to the Law Commission equity investment example for a moment, though,
a further key point is that it focusses on the fi nancial risk of a single sustainability issue to
a single company. Clearly, this may not be material to a pension scheme as an institutional
investor. Trustees need to consider the issues in relation to the other types of pension scheme
investment product and asset class they may more typically use, and to look across the scheme’s
portfolio as a whole in order to make decisions about sustainability issues at the investment
strategy level. Thus, in practice, the concept of fi nancial and fi nancially material factors has to
be scaled up from the Law Commission’s example and painted onto a much broader canvas.
This point is increasingly being recognised and is refl ected, for example, in the greater focus
on asset classes other than equities in the 2020 revision of the UK Stewardship Code.
33
All
the while, of course, trustees and their advisers may also be taking care not to stray into non-
fi nancial territory.
Conclusions on fi nancial and fi nancially material factors
It is diffi cult to take issue with the basic legal reasoning underlying the ‘fi nancial (fi nancially
material)’ concept, which, as we will see, is essentially that trustees should seek to identify and
take account of factors that are relevant to the exercise of the investment power. This category
is, potentially, extremely fl exible. However, the challenge is identifying and defi ning what
constitutes fi nancial or fi nancially material in a particular context, when a particular factor falls
into a category, and when it does not. The problem is compounded when investments become
more complex and are considered strategically over the time over which they are held and the
investment time horizons of the scheme.
The next section will suggest how, by rediscovering the core legal analysis underpinning
the concept of fi nancial (fi nancially material) factors, and some other perhaps less widely
discussed points from the Law Commission’s work, practitioners may be able to move beyond
the tricky categorisation problems outlined above and towards a new and wider perspective
on the fi duciary duty.
Towards a new perspective
Starting point
It might be helpful to begin our reappraisal at the very beginning.
In England and Wales, occupational pension schemes are purpose trusts. Their purpose
is to provide the stated retirement benefi ts.
34
It is important to note that in contrast to some
of the trusts considered in the authorities on non-fi nancial factors above, occupational pension
schemes rarely, if ever, have wider purposes such as environmental protection or the social or
economic improvement, and in some cases may even expressly exclude these.
35
33 For example see Principle in the UK Stewardship Code (2020), p 15, www.frc.org.uk/getattachment/5aae591d-d9d3-
4cf4-814a-d14e156a1d87/Stewardship-Code_Dec-19-Final-Corrected.pdf, accessed 21 September 2022.
34 Potentially by reference to ‘acceptable cost to the employer‘ or similar: see Pollard, D, The Law of Pension Trusts
(Oxford University Press, 2013), p 171. However, see also ‘Redefi ning purpose’ below.
35 For example, the trust deed of the Airways Pension Scheme expressly restricted the scope for making ‘benevolent
or compassionate’ payments of a gratuitous kind that were not pension benefi ts in accordance with the scheme
provisions – see British Airways plc v Airways Pension Scheme Trustee Ltd [2018] EWCA Civ 1533. Note that in that
case, whilst one of the employer’s arguments was that the trustee’s actions fell foul of this ‘benevolence’ restriction,
the Court of Appeal ultimately found that the trustee’s actions failed the proper purposes test on different grounds.
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It is said that any trustee’s primary duty is to ‘promote’ the purpose for which the trust
was established.
36
To this end, an occupational pension scheme’s trust deed and rules confers
certain powers and discretions upon the trustees. The power of investment is one such power.
How, then, should that power be exercised?
Best interests and proper purpose
The most famous case on occupational pension scheme investment suggested that a trustee’s
key duty when exercising the investment power is to act in members’ best (fi nancial) interests.
In Cowan v Scargill, Megarry VC held:
The starting point is the duty of trustees to exercise their powers in the best interests of
the present and future benefi ciaries of the trust, holding the scales impartially between
different classes of benefi ciaries. This duty of the trustees towards their benefi ciaries is
paramount. They must, of course, obey the law; but subject to that, they must put the
interests of their benefi ciaries fi rst. When the purpose of the trust is to provide fi nancial
benefi ts for the benefi ciaries, as is usually the case, the best interests of the benefi ciaries
are normally their best fi nancial interests. In the case of a power of investment, as in
the present case, the power must be exercised so as to yield the best return for the
benefi ciaries, judged in relation to the risks of the investments in question; and the
prospects of the yield of income and capital appreciation both have to be considered in
judging the return from the investment.
37
This decision has been criticised.
38
The Law Commission observed that it has been the subject
of ‘great debate’, noting that the references to yielding the best return for the benefi ciaries
have been interpreted in some quarters as imposing a duty on trustees to seek maximum
returns.
39
The Law Commission dismissed the ‘maximise returns’ interpretation, and pointed
to external sources suggesting this was not Megarry VC’s intended meaning. It is suggested
that any close reading of the judgment, in particular the full passage at paragraphs [41]–[52]
in its context, supports this, and makes clear that the case is no authority for the ‘maximise
returns’ approach at all. At most, it describes a duty to act in members’ best fi nancial interests
(whatever those are).
The law has moved on since 1984, and the more orthodox view of this duty today
is that the trustees must exercise the investment power for its proper purpose: that is, the
purpose for which it was conferred upon them and not for any other or collateral purposes.
The Law Commission described this as follows: ‘A trustee should start with the trust deed
and ask: what is the purpose of the power I have been given, and how can I use the power
to promote that purpose?’
40
This interpretation is consistent with a long line of case law
36 LC2014, p 109, Re Courage Group Pension Scheme [1987] All ER 528 at 538, Pollard, D, The Law of Pension Trusts,
(n 34 above), pp 169–175 and Pollard, D, Pensions, contracts and trusts: legal issues on decision making, (n 29 above),
Pts 4 and 5, and Hayton, D, Matthews, P and Mitchell, C (Eds), Underhill and Hayton: the Law of Trusts and Trustees
(Lexis Nexis, 2010), p 881.
37 [1985] Ch 270 at [41].
38 See, for example, Daykin, S (above n 6), 173 and the UNEP report authored by Freshfi elds Bruckhaus Deringer,
‘A legal framework for the integration of environmental, social and governance issues into institutional investment’
(October 2005), p 9, www.unepfi.org/fileadmin/documents/freshfields_legal_resp_20051123.pdf, accessed
21 September 2022.
39 LC2014, p 72.
40 Ibid, p 109.
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concerning other trustee powers.
41
To reconcile this concept with the idea of best (fi nancial)
interests from Cowan v Scargill, it is helpful to look at Merchant Navy Ratings Pension Fund
Trustees Limited v Stena Line and others,
42
which concerned the propriety of the trustee’s use of
a power of amendment to introduce a new scheme funding regime. This case seems generally
to have been accepted as clarifi cation that the ‘best interests’ formulation is, in effect, a gloss
on the core trustee duty to promote the purposes of their trust and to use their powers for the
purposes for which they were conferred. Best interests and proper purpose are different sides
of the same coin.
Since the core duty is best understood as focussing on proper purpose, the next question
is what the purpose of the investment power actually is.
The Law Commission described it thus: ‘The primary purpose of the investment power
given to pension trustees is to secure the best realistic return over the long-term, given the
need to control for risks.’ There two aspects of this statement that are worth focussing on.
First, it is important to note that, having ruled out a duty to ‘maximise’ fi nancial returns,
the Law Commission also ruled out a duty framed around achieving ‘reasonable’ returns, or
similar.
43
So clearly, when talking about ‘best realistic return’, the Law Commission envisages
that there is an optimal risk-adjusted returns standard that trustees should be aiming for in order
to exercise the investment power for its proper purpose.
Secondly, the analysis encapsulated in the Law Commission’s formulation is easy to
follow from a strict theoretical pensions law perspective. But as a defi nition of the purpose of
the investment power, it is not free from diffi culties in practice. Above all, a literal reading of the
phrase ‘best realistic return over the long-term, given the need to control for risks’ can tend to
reduce investment considerations to binary comparison of the risk and return characteristics of
‘specifi ed investment A’ versus ‘specifi ed investment B’. Perhaps this approach was intended in
part as a direct response to Cowan v Scargill and some of the misapprehensions about that case
and the ‘maximise returns’ idea.
44
Unfortunately, the reference to ‘best realistic return’ may
not have closed the door as fi rmly on these misapprehensions as the Law Commission might
have wished. The language still allows the narrow comparative approach, and this narrower
formulation of the purpose of the investment power has a number of challenges:
(a) It makes no express reference at all to the fundamental reasons why trustees should seek
risk-adjusted fi nancial returns in the fi rst place. It implies that achieving the best realistic
risk-adjusted returns is the end goal in itself.
(b) The phrase is brief and so does not expressly capture the wider context of the scheme’s
portfolio within which the specifi c investments may be held, where risks and returns are
likely to be diversifi ed across the whole portfolio. This has to be read in.
(c) It makes no reference to time horizons other than a long-term time horizon. The
long-term may not be the time horizon driving the particular investment decision in
question.
41 See, for example, Re Courage Group Pension Schemes [1987] 1 All ER 528 at 536 (Millet J), Hillsdown Holdings v Pensions
Ombudsman [1997] 1 All ER 862 at 879 and 880 (Knox J) and Edge v Pensions Ombudsman [2000] Ch 602 at [50]
(Chadwick LJ). For further discussion see Pollard, D, The Law of Pension Trusts (above, n 34), Ch 9.
42 [2015] EWHC 448 (Ch) at [228]–[229] (Asplin J).
43 LC2014, pp 95, 112, 128.
44 On its facts the investment decision in Cowan v Scargill was a more clear-cut comparative exercise, posing a choice
between investing in UK coal or in coal overseas. The case implied that if an ‘ethical’ or non-fi nancially motivated
investment strategy could be expected to be equally benefi cial as a comparable fi nancially motivated strategy, there
would be no impediment to adopting it – an idea which seems to lie at the root of much of the subsequent debate.
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(d) It assumes there is an alternative investment product (or investment strategy) which is
available and which can readily be compared against ‘investment A’. In fact, this is likely to
be diffi cult or impossible to establish as part of a practical decision-making exercise. One
example of this is the well-known thought experiment which challenges whether trustees
can properly invest in green gilts at a ‘greenium’ when an alternative cheaper ‘standard’ gilt
is also available which is expected to provide a similar return for the same level of credit
risk.
45
Where is the best realistic risk-adjusted return in this scenario? Some argue that the
proper answer is to choose the brown gilt. In reality, there are arguments that on closer
examination, green gilts and standard gilts are not as directly comparable as the example
implies.
46
If that is right, the comparative approach is potentially conceptually fl awed.
Thus, it is suggested, we need to look again at how we defi ne the proper purpose of the
investment power.
Redefi ning purpose
A learned judge has warned against setting out propositions that are too general and ‘shorn of
the context of a particular scheme.’
47
Any sort of exercise to clarify the proper purpose of the
investment power in a new defi nition is, of course, likely to need signifi cant further work.
Having said that, it is suggested there because there are ‘gaps’ in the LC2014 formulation, as
outlined above, this exercise could be worthwhile. It is also tentatively suggested that one way
to address the gaps might be to look at defi ning the purpose of the investment power in a way
that more expressly relates back to the reason the power is granted to occupational pension
scheme trustees in the fi rst place: namely, to deploy the scheme assets so as to best provide,
in the circumstances of the scheme, the various benefi t entitlements within that scheme (with
desired risk-adjusted returns being decided accordingly).
48
A more purposive formulation such
as this would seem to avoid the problem of steering readers towards comparative approaches,
capturing instead the more fundamental ideas of the goals, standards of care, execution and
context that are necessary in order to arrive at an investment decision which promotes the
overall purpose of the pension scheme trust.
Whatever legal formulation of the investment power’s purpose is preferred, it is suggested
that it ultimately boils down to an even simpler central ‘exam question’ that trustees could ask
themselves (and their advisers) whenever they are considering a proposed new investment or
investment strategy:
How is this helping us best achieve our objective of providing the benefi ts the scheme
has been set up to provide?
The trustees’ practical answer to that question, and therefore the scope for taking different
issues, including sustainability considerations, into account when investing will then lie in the
45 See Bennett, P, (above n 13).
46 As was discussed at a joint seminar of the Association of Pension Lawyers and Society of Pension Professionals on
30 June 2022 regarding ESG and fi duciary duty, viewed by the author (membership required for access).
47 British Airways, (above n 35) at [61] per Patten LJ (dissenting).
48 The views of the sponsoring employer could also be relevant here (see n 22 above). In a defi ned benefi t scheme,
the concept of the ‘circumstances’ of the scheme mentioned in this formulation may include among other things the
strength, longevity and visibility of the sponsoring employer’s covenant.
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outcome of the decision-making process that the law expects trustees to follow and the duty
of care trustees owe when doing so. Consequently, it is to these aspects that we will now turn.
Decision-making process
What follows can only be the briefest possible summary of the huge amount of law in this area.
To begin with, as a matter of general trust law, a trustee’s power of investment is categorised
as an administrative power.
49
This imports a series of well-known duties around how the
investment power should be exercised.
50
These include duties to avoid formal or procedural
defects and within the scope of the power, but there are four other key points to focus on here:
(a) Ongoing duty to consider exercising the power: In circumstances where trustees have been given
an administrative power, as opposed to being under an obligation to act in a particular way,
trustees must at a minimum consider from time to time whether to exercise the power
which they have been given.
51
(b) Duty to give due or ‘properly informed’ consideration to any exercise of the power: Where trustees
decide to exercise a power which they have been given, they must act in good faith
and take reasonable steps to gather information which is relevant to the exercise of that
power.
52
(c) Duty to consider relevant factors (and no irrelevant factors) when taking the decision: This is one of
the key duties for the purposes of this article and it is discussed in further detail below.
53
(d) Duty to reach a decision that is not irrational or perverse: Even where the correct factors have
been taken into account and the decision-making process is otherwise proper, a decision
can still be overturned if the trustees reach a conclusion which no reasonable decision-
maker could have reached.
54
It is well established that where trustees have followed a proper decision-making process,
complying with these duties and not reaching an outcome that is irrational or perverse, a court
would not overturn the decision if someone else in the same position might have reached a
different conclusion.
55
The duty to consider relevant factors is particularly signifi cant in two respects.
First, it defi nes the legal fi lter through which all considerations, including sustainability
considerations, need to pass before they can form part of a trustee investment decision. It is
clear from the case law that this fi lter is not whether an issue is non-fi nancial or fi nancially
material (or otherwise), but whether or not the consideration is relevant in the exercise of the
investment power.
49 Tucker, L et al, Lewin on Trusts (20th ed, Sweet & Maxwell, 2020), Vol II, pp 8–9.
50 See, generally, the discussion in Lewin on Trusts (above n 49), Ch. 29.
51 Sieff v Fox [2005] EWHC 1312 (Ch).
52 Kerr v British Leyland [2005] 17 PBLR. Most occupational pension scheme trustees are also required by statute to take
proper advice on investment matters – see s 36 of the Pensions Act 1995.
53 Edge v Pensions Ombudsman (above n 41), Braganza v BP Shipping Ltd [2015] UKSC 17. As part of this, trustees must
set aside their personal views and beliefs.
54 Ibid, see also Harris v Lord Shuttleworth [1994] ICR 1991, Braganza, Op. cit., and Pollard, D. Pensions, contracts and trusts:
legal issues on decision making, Op. Cit, Chs. 51–55.
55 Edge v Pensions Ombudsman, (above n 41), [50].
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This is a critical point: the case law recognises a broad but binary distinction between
relevant and irrelevant factors in a decision, rather than a need to sub-categorise considerations
in other ways.
Secondly, identifying which considerations are relevant, which are irrelevant, and how
much weight to give any particular consideration in the decision, are in the fi rst instance
matters for the trustees to determine in light of the purpose of the investment power and the
specifi c facts and context. Trustees are not required to identify and consider every conceivable
relevant factor, but the duty of proper consideration implies at the very least a requirement
actively to think about what obviously ought to be considered and what other issues are or are
not permitted to be taken into account.
56
It is also clear that in the investment context, these
decisions involve matters of trustee judgement as much as hard data analysis.
57
Refocussing on relevance (and irrelevance)
Within the case law, the scope for taking any particular sustainability consideration into
account therefore depends on its relevance to the investment decision that is being taken,
which is a matter of trustee judgment after giving the issues proper consideration and
appropriate weight within the decision, in the circumstances of the scheme. There does
not seem to be any legal requirement for trustees to re-cut or reclassify the factors in their
decision in a different way to this.
On a practical level it is also suggested that it is becoming diffi cult to sustain a view that
sustainability considerations will always be entirely irrelevant factors for the purposes of the
legal duties, or even that there is insuffi cient evidence to support their potential relevance
to investment decisions, such that they should automatically be excluded from every trustee
investment decision. Over the period since LC2014 then there has been further considerable
thought, analysis and policy guidance linking sustainability considerations to wider investment
decisions.
58
Given the above, it is suggested that:
(a) There is nothing that means sustainability considerations are so inherently irrational or
irrelevant to trustee investment decision-making they should invariably be disregarded.
Rather, it is suggested that, where supported by investment analysis, sustainability
considerations can be and are relevant to investment risk and opportunity. This does
not mean that sustainability issues will always sway a decision-maker irrespective of
the circumstances. What it does mean is that the better legal starting point when
facing an investment decision is to assess, with advice as needed, what role the given
56 For a further discussion of these issues, see Pollard, D, Pensions, Contracts and Trusts: Legal Issues on Decision Making,
(above n 30), pp 235–333.
57 LC2014, pp 95, 126.
58 From the author’s discussions with investment consultants, he is aware of a growing body of experience that suggests
integrating ESG into investment strategy decisions can be value-additive, and that ESG factors can be fi nancially
material. This was also discussed by speakers at the joint Association of Pension Lawyers and Society of Pension
Professionals webinar on ESG and fi duciary duty on 30 June 2022, viewed by the author (access requires membership).
Another example is the government’s statutory guidance on climate change governance under ss 41A(7) and 41B(3)
of the Pensions Act 1995, which expressly sets out the policy view that climate change risks are fi nancial risks – see
Department for Work and Pensions, ‘Governance and reporting of climate change risk: guidance for trustees of
occupational pension schemes’, June 2021, pp 12–13: https://assets.publishing.service.gov.uk/government/uploads/
system/uploads/attachment_data/fi le/1006024/statutory-guidance-fi nal-revised.pdf, accessed 21September 2022.
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sustainability consideration can and should properly play in the decision, having regard
to the purpose of the investment power and the wider context of the scheme in
question (see above).
(b) The general decision-making duties give trustees an extremely wide discretion to
construct their decisions, and the considerations that feed into them, as they see fi t – as
long as the broad basic requirements, including as to proper consideration, rationality, and
relevance, are met.
(c) The ‘fi nancially’/’fi nancially material’/’non-fi nancial’ concepts (and the sub-
categorisations they involve) are not hard principles that were articulated within the
case law – they are an analytical gloss upon it.
(d) Consequently, the fundamental legal requirement is not fi nancial, fi nancial materiality or
the two-limb non-fi nancial factors test, but relevance.
By linking contemporary investment analysis with a better understanding of this fundamental
legal requirement for relevance, it is the author’s view that practitioners will create the greatest
potential for the two key issues mentioned at the start of this article (investment reality and
legal principle) to come into alignment. It is therefore in this territory where, in the author’s
view, there lies the greatest potential to resolve the current uncertainties about the fi duciary
duty when investing. Instead of focussing on debates about whether a factor is fi nancially
material or non-fi nancial, by fi rst articulating the criteria of relevance and the proper purpose
of the investment power and then working collaboratively with investment advisers to establish
whether the investment analysis supports a given sustainability consideration as relevant to
that purpose, trustee legal advisers should be able to advise with greater clarity on whether the
trustee’s decision-making is following an appropriate legal process such that it should not be
overturned.
59
None of this is especially radical. Nor, in one sense, is it inconsistent with the Law
Commission’s analysis. LC2014 defi ned fi nancially material factors as ‘any factor which is
relevant to trustees’ primary investment duty of balancing returns against risks’ (emphasis added).
As drafted, this defi nition is in itself extremely broad but more importantly, it seems clearly
founded on the idea of relevance. Trustees and advisers could fi nd considerable assistance in
refl ecting on the breadth of this concept. To put it another way, a fi nancially material factor
will by defi nition be a relevant factor. And if a consideration is relevant, it should be taken
into account. If it is irrelevant, it should be disregarded irrespective of whether it might be
categorised as fi nancial or non-fi nancial in nature.
However, lest this approach should be criticised as simply moving the goalposts from
a ‘non-fi nancial’ and ‘fi nancially material’ dichotomy to a division between ‘relevant’ and
‘irrelevant’, it is important to recall that the Law Commission model involves four sub-
categories: fi nancial, fi nancially material, non-fi nancial, and impermissible (ie irrelevant): see
above. It places four options in front of trustees when categorising an issue for investment
decision-making, whereas the revised approach only involves a choice between two, addressing
the categorisation problem within the current model and opening a clearer path towards a fi nal
decision.
59 The duty of care, discussed below, is also important to this.
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Conclusions on the relevant factors test
By rediscovering the ‘relevant factor’ threshold, and its connection to the proper purpose
of the investment power, practitioners may be able to adopt a more focussed and purposive
approach to the fi duciary duty which asks trustees and their advisers to address:
● how the investment power can best be used to deliver benefi ts over the time-horizons
of the scheme; and
● how their sustainability considerations fi t within that picture.
Of course, the practical reality of these decisions would not be easy. The investment issues are
nuanced and neither the real world of investment nor the job of a trustee are straightforward.
But it should be clear that a revised perspective based upon relevance would help resolve the
uncertainties around the fi nancial, fi nancially material and non-fi nancial categories, allowing
trustees and advisers to focus instead on the more pressing questions of why and how any given
issue, including a sustainability consideration, is being, or should be, properly considered.
Duty of care
Another step that may move us forward would be to rediscover the trustee duty of care when
investing. In fairness, this does often feature in the analysis and commentary, but it seems to
have received comparatively less attention than the ‘fi nancially material’/‘non-fi nancial’ debate.
The Law Commission felt that the duty of care sits alongside the trustees’ other more
specifi c duties when exercising a power (such as those outlined above).
60
The best-known case
law formulation is that the duty is ‘to take such care as an ordinary prudent man would take
if he were minded to make an investment for the benefi t of other people for whom he felt
morally bound to provide.‘
61
This does not mean the elimination of risk when investing,
62
nor
is it to be assessed with the benefi t of hindsight (or with the expectation of prophetic vision).
63
This should be reassuring to many trustee boards when grappling with the complexity of
sustainability issues.
The state of the art
Of more immediate interest here, however, is the judicial recognition that the trustee’s
investment duty of care evolves. In Nestle v National Westminster Bank, Hoffman J (as he then
was) held that the Re Whiteley formulation is:
… an extremely fl exible standard capable of adaptation to current economic conditions
and contemporary understanding of markets and investments. For example, investments
which were imprudent in the days of the gold standard may be sound and sensible
in times of high infl ation. Modern trustees acting within their investment powers are
60 LC2014, p 53.
61 Re Whiteley (1886) 33 Ch D 347 at 355. This was applied in Cowan v Scargill (above n 21), at [50], noting that the duty
‘is not discharged merely by showing that the trustee has acted in good faith and with sincerity. Honest and sincerity
are not the same as prudence and reasonableness.’ See also Pollard, D, ‘The “prudence” test for trustees in pension
scheme investment: just a shorthand for “take care”’, (2021) 34 TLI 215.
62 Re Godfrey (1883) 23 Ch D 483 at 493.
63 Duchess of Argyll v Beuselinck [1972] 2 Lloyd’s Rep 172; Nestle v National Westminster Bank (1996)10 TLI 113 at [21].
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entitled to be judged by the standards of current portfolio theory, which emphasises the
risk level of the entire portfolio rather than the risk attaching to each investment taken
in isolation.
64
Sometimes cited as specifi c support for portfolio theory, this authority is actually much wider
than that: it establishes that in discharging the duty of care, trustees can (and arguably should)
have regard to contemporary investment theory, of which portfolio theory was merely a
prescient example at the time the case was decided.
This is signifi cant in relation to sustainability considerations, where industry thinking is
continuing to develop. A discussion of the investment theory is beyond the scope of this article,
but the concept of an evolving duty of care means that at a minimum it can be argued that
trustees should discuss with their advisers how far contemporary investment analysis is revealing:
● how sustainability issues may affect particular scheme investments or asset classes over
the short-, medium- and long-term (noting, as above, that these risks can sometimes
crystallise in sudden or unexpected ways);
● how sustainability considerations may correlate with systemic risks in the economies and
fi nance which may now be starting to crystallise, whereas previously these issues may
have been characterised as too remote or nebulous to be properly relevant to trustee
investment decisions; and
● how the above may affect the investment strategy.
65
In that context, the question of how investment risks and opportunities arising from sustainability
can be addressed within the portfolio becomes a legally relevant issue. Put bluntly, is the
portfolio (and therefore the purpose of the scheme) ultimately best served by deploying assets
in ways that contribute to and thus reinforce exposure to economic and social systems which
may not be sustainable over the time-horizon of the scheme or which increase the risk of
short-term downside, while the scheme may now have other or better opportunities to avoid
these issues by pursuing an alternative investment course?
As our understanding of the interplay between sustainability considerations, systemic risk
and investment performance evolves and becomes more nuanced and sophisticated, the trustee
standard of care likewise evolves. We urgently need a debate around ‘the state of the art’ here.
Eight years after the fi rst Law Commission report, the position in relation to the relevance
of sustainability risks and opportunities, including systemic risks, to the duty of care when
investing is surely ripe for reappraisal.
Stewardship and engagement
A second feature to recover from the duty of care is the idea that it encompasses a degree of
active stewardship of investments. The facts of a key case in this area, Bartlett v Barclays Bank
Trust Co Ltd, are relatively unlikely to arise in the context of many occupational pension scheme
64 Nestle v National Westminster Bank (above n 63), at [21].
65 See Cowan v Scargill (above n 21), at [61] and LC2014, in particular the discussion of improving of the UK economy
as a non-fi nancial factor at pp 117–118. Practical areas that would, in the author’s view, benefi t from further discussion
and education as between lawyers, investment consultants and economists are: (i) the emerging commercial and
fi nancial evidence to support ESG considerations as value-additive within investment strategies, and (ii) the extent
to which systemic economic risks are starting to feature, particularly for open and/or relatively immature pension
schemes.
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investment strategies today. In the case, the defendant owned 99.8 per cent of a company
which made a bad business decision, resulting in a loss to the trust, in circumstances where the
trustees had had little practical engagement with the company directors other than through
information provided at AGMs. The court found that because of the controlling position it had
taken the bank was liable to make good the loss to the trust. The circumstances were extreme,
but the key point is that the court applied the ‘prudent man of business’ standard to establish
the level of stewardship of the company that ought to have been applied:
Appropriate action will no doubt consist in the fi rst instance of inquiry of and consultation
with the directors, and in the last but most unlikely resort, the convening of a general
meeting to replace one or more directors. What the prudent man of business will not do
is to content himself with the receipt of such information on the affairs of the company
as a shareholder ordinarily receives at annual general meetings.
66
Stewardship and engagement are also growing areas of focus for pensions policymakers.
Regulations already require most occupational pension scheme trustees to set out in a
statement of investment principles their policies as to the exercise of rights (including voting
rights) and engagement activities in relation to their investments; and this requirement is to be
broadened and deepened through statutory and non-statutory guidance.
67
Thinking on this
area has developed further since LC2014 and LC2017, with suggestions that active stewardship
and engagement can positively contribute to investment value.
68
By providing scope for
broader ongoing strategic investment activity as a potential alternative to blunt investment and
disinvestment decisions, stewardship and engagement also provide a potential practical answer
to the challenge that individual schemes cannot be expected to act on sustainability because
they are not large enough to infl uence markets or investee behaviour on their own.
It therefore appears from the case law that stewardship is better seen as a legitimate
investment risk mitigation tool for trustees as part of the duty of care. The types and level of
stewardship activity that are needed to discharge that duty are fl exible, depending in part upon
the level of exposure to and control of the investment. In the context of typical occupational
pension scheme investment strategies today, which are often highly diversifi ed and which
involve comparatively little direction from trustees below the strategic level (partly for
regulatory reasons), one might therefore expect trustees to be at relatively low risk of breaching
this duty. Nevertheless, it is suggested that the duty of proper consideration means trustees are
not at liberty to ignore questions of stewardship entirely. This is particularly the case in relation
to system-wide sustainability risks such as climate change which are much harder to address by
diversifi cation within the portfolio.
66 [1980] Ch 515.
67 Regulation 2(3)(c), the Occupational Pension Schemes (Investment) Regulations 2005 (SI 2005/3378). This provision
derives from SRD II (Directive EU 2017/828), refl ecting rising expectations among European policymakers as to
standards of stewardship by large institutional investors. Separately, occupational pension scheme trustees are also
required to report publicly on, among other things, their key voting behaviour in an annual ‘implementation statement’
as part of the scheme accounts: see reg 12(5) of the Occupational Pension Schemes (Disclosure of Information)
Regulations 2013, as amended (SI 2013/2734). As to the next developments on and from 1 October 2022, see the
Department for Work and Pensions Consultation Response ‘Climate and investment reporting: setting expectations
and empowering savers’ (June 2022), www.gov.uk/government/consultations/climate-and-investment-reporting-
setting-expectations-and-empowering-savers/outcome/government-response-climate-and-investment-reporting-
setting-expectations-and-empowering-savers, accessed 21 September 2022.
68 See for example, Wallis, R (Ed), ‘How ESG engagement creates value for investors and companies, (Principles for
Responsible Investment, 2018), www.unpri.org/research/how-esg-engagement-creates-value-for-investors-and-
companies/3054.article, accessed 21 September 2022.
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Conclusions on the duty of care
The duty of care complements a refreshed decision-making duty based on relevant factors, by
prompting trustees to take account of both evolving investment market thinking, and to think
about how to manage investment risk in the portfolio by prudent and proportionate but active
stewardship.
Investment policies and disclosures
Moving away from the case law, our fi nal stop brings us to the extensive sustainability-related
legislation that now applies in relation to occupational pension scheme investment. Among
others that could have been chosen,
69
the example here is the requirement to have a statement
of investment principles setting out, among other things, the trustees’ policies in relation to:
(a) fi nancially material considerations over the appropriate time horizon of the investments
including how those considerations are taken into account in the selection, retention and
realisation of investments; and
(b) the extent (if at all) to which non-fi nancial matters are taken into account in the selection,
retention and realisation of investments.
70
Further regulations require the statement of investment principles to be displayed on a publicly
accessible website.
71
These requirements are clearly derived from LC2014: fi nancially material considerations
are widely and non-exhaustively defi ned as including (but not limited to) environmental,
social and governance considerations (including but not limited to climate change), which
the trustees of the trust scheme consider fi nancially material. Non-fi nancial matters means the
views of the members and benefi ciaries including (but not limited to) their ethical views and
their views in relation to social and environmental impact and present and future quality of life
of the members and benefi ciaries of the trust scheme.
72
The structuring of these obligations is interesting. First, the regulations do not impose
a direct duty to take account of fi nancially material considerations or non-fi nancial matters.
Rather, they are a requirement to set out policies on these matters. Of course, in order to be
able to state these, trustees need to have actively turned their minds to what those policies
should be. The regulations are, in effect, a ‘call to action’. Secondly, because the statement of
investment principles is publicly available, there is the prospect of greater transparency (and
thus accountability) for the scope and quality of those policies as the scheme compares itself to
its peers, or as members or other stakeholders engage with the trustee about the stated policies.
In another forum, the author has argued that as a result of this, industry best practice is likely
69 Another example is the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations
2021 (SI 2021/839).
70 Regulation 2(3)(b)(vi) and (vii) of the Occupational Pension Schemes (Investment) Regulations 2005 (SI 2005/3378
as amended).
71 Regulation 29A(1A) of the Occupational Pension Schemes (Disclosure of Information) Regulations 2013
(SI 2013/2734 as amended).
72 Regulation 2(4), the Occupational Pension Schemes (Investment) Regulations 2005 (SI 2005/3378) as amended.
These terms appear to be intended to broadly refl ect the ‘fi nancially material’/‘non-fi nancial’ formulation developed
by the Law Commission, though there are differences in precise terminology. The statutory language is not necessarily
inconsistent with a reframed general fi duciary duty of the type suggested above because the statutory defi nition of
‘fi nancially material considerations’ is extremely wide and is framed by reference to each trustee’s subjective judgement.
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to develop over the coming years towards an emphasis on more focussed and actionable policy
statements than may have been the case in the past, drawing a distinction between these and
the Pensions Regulator’s concept of higher-level ‘investment beliefs’.
73
By requiring trustees to take this approach, the statutory regime in effect acts to reinforce
the potential relevance of sustainability considerations within the fi duciary duty, and at the
very least to encourage trustees to consider the issues.
Conclusions
There remains a degree of caution about the extent to which sustainability considerations
are compatible with occupational pension trustee fi duciary duties when investing. There are
some continuing uncertainties about the model fi rst put forward by the Law Commission in
2014. Some of these are substantive uncertainties about the state of the law as it applies to
occupational pension schemes. In other areas the law is clearer but its practical application has
arguably become clouded.
This article has sought to outline a slightly different way of looking at the fi duciary duty,
in line with the established case law but with a view to moving past the categorisation problem
of fi nancial/fi nancially material/non-fi nancial factors. The article has suggested that it might
be possible to achieve this by rediscovering the underlying key legal principles. Specifi cally,
this involves:
● refocussing legal analysis on helping trustees properly to identify and consider the relevance
of different investment issues and strategies, including sustainability considerations, to
their ultimate purpose of providing benefi ts in the specifi c circumstances of each scheme.
Whilst this is intensely fact specifi c, it is suggested that sustainability considerations can in
theory (and increasingly in practice) be highly relevant in this context;
● as part of the duty of care, prompting trustees and advisers actively to enquire into ‘the
state of the art’ in investment thinking and how this affects the scheme, including the
developing understanding of specifi c sustainability risks and opportunities and risks arising
from unsustainable economic or social systems, and then looking at how to incorporate
this evolving thinking into investment strategies; and
● the role of active stewardship as a matter of both the investment duty of care and the
statutory requirement for (actionable) investment policies.
There is a lot more work to do on this topic, but perhaps there are the beginnings of a
conversation here. The legal principles interact strongly with investment analysis and
economic and practical circumstances, both of each scheme and more widely. Sustainability
considerations can most easily be taken into account where the investment reality aligns with
an understanding of the law. This article has sought to outline a legal perspective which
may help create that alignment – but the development of workable practical approaches in
this complex area will, above all, best be achieved through close collaboration and genuine
dialogue between occupational pension trustees and their legal and investment advisers.
73 See ‘ESG: from policies to practice’, specialist session webinar at the PLSA ESG Conference 2021, www.traverssmith.
com/knowledge/knowledge-container/esg-from-policies-to-practice-pensions-and-lifetime-savings-association-plsa-
esg-conference-2021/, accessed 21 September 2022.
