Issue: April/June 2010


Out with the old, in with the new

Fund trustees and asset managers can be held liable, respectively for breach of fiduciary duty or professional negligence, if they focus on financial returns to the exclusion of all else.

How radically the 2009 financial crisis has changed the pensions world. A critical aspect is in the fiduciary duty of retirement-fund trustees. In the past, the prevalent legal view was that trustees focus exclusively on their funds’ financial returns. At most, their duty didn’t preclude – and only in certain circumstances required – that they embrace environmental, social and governance (ESG) considerations in making their mainstream investment decisions.

No longer. It is now contended that fund trustees and asset managers who ignore ESG, or funds’ expert consultants who fail to be proactive in raising with them the relevance of ESG, can find themselves legally liable for breach of fiduciary duty (in the case of trustees) or professional negligence (in the case of inactive or reactive asset managers and consultants).

This is cast in stone by a revised document known as ‘Fiduciary II’, lead-authored by lawyer Paul Watchman and published with authority by the UN Environment Programme Finance Initiative (UNEP FI). It adds muscle to the bones of the UN Principles for Responsible Investment. It also strengthens, from voluntary compliance to something more, the recommendations of King III on stakeholder engagement with companies in which pension funds are invested.

Inescapably on the ESG agenda

Inescapably on the ESG agenda

Across the world, the UN principles now have more than 560 signatories. They include over two dozen South African asset managers and so far a handful of the largest pension funds since the Eskom and Transnet funds recently followed the lead of the Government Employees Pension Fund (TT Sept-Nov ’09). For them, and for those thinking of making a similar commitment, ‘Fiduciary II’ is to be acknowledged as their constant beacon.

Success of the UNEP FI initiatives to engage the investment market, in re-assessing the legal meaning of fiduciary duties and embracing responsible investment, did not occur in isolation from market forces, Watchman points out: “In the last two years the financial world has been turned upside down. If greed was ever good or bankers had a reputation for financial prudence, this is no longer the case”.

What’s more, market regulators have expressed

doubt as to the social utility of various financial activities that have proliferated over the past several years. In the UK, for instance, Lord Turner has described some as “socially useless”.

The predominant use of language in the financial world has changed. The shift can be gleaned, Watchman observes, from examining the changing use of different financial expressions. They include:

  • Replacement of the need for short-term financial returns with the need for sustainable finance;
  • Demand for corporate governance discharged by an effective and financially-expert board of directors;
  • Requirements to overcome the shortcomings of inept directors found to have been asleep at the wheel of financial juggernauts or inappropriately awestruck by maverick or charismatic chief executives;
  • Ousting of incentive structures based on rewards and bonuses for short-term performance by incentive schemes based on just rewards for longterm success;
  • Claw-back of unjustified rewards;
  • Recognition that financial instruments, such as derivatives and swaps, are not so much riskavoidance mechanisms but capable of facilitating gaming and with it a casino culture that creates toxic debt;
  • Acceptance that belief in an almost-papal infallibility of private equity and hedge funds, to produce high short-term returns, was misplaced;
  • Understanding that light-touch regulation can be soft-touch.

Much of the financial crisis might well have been worse without the intellectual infrastructure provided over the previous five years by UNEP FI reports, significantly endorsed in SA by the King code, which emphasised the need for a more sustainable investment approach and for ownership participation in financial dealings.

Against this, however, is the argument that the crisis – to which pension funds, by their nature, are inevitably vulnerable – has led to a less restrictive interpretation of fiduciary duties. Without doubt, says Watchman, there is some truth in observations that financial markets (as well as various banks and politicians) have actually increased their hypocrisy and resistance to ESG by merely paying lip service to it.

But these trends, he believes, should not be exaggerated. More likely, they reflect the confusion arising from a deep financial crisis where inconsistency in approach is shown by violent swings from hyperactivity to paralysis in decisionmaking.

This, he suggests, is typical of institutions faced with threats on many levels: “After the credit crunch there should be no going back for banks and pension funds to business as usual. Transparency and accountability, sustainable finance and long-term planning, are here to stay.”


The UNEP FI-sponsored ‘Fiduciary II’ report has three main elements:

  • Exploration of the legal perspective on how best to operationalise the integration of ESG issues into the investment process, particularly with respect to investment mandates and investment-management contracts;
  • Analysis of a pioneering survey sent by the UNEP FI Asset Management Working Group to investment-management consulting firms. It covers ESG issues as they relate to various aspects of the investment-management process, including legal language;
  • A literature review that focuses on practical developments on the integration of ESG issues into the investment process, providing insights into how institutional investors have adopted and can adopt them.

A key conclusion is that, where retirement-fund trustees integrate ESG issues into their decision making, these issues should be embedded in the legal contract between asset owners and asset managers. Implementation of this framework would then be governed by periodic ESG-inclusive reporting.

In SA it’s a good-governance requirement under FSB circular PF130 for retirement funds to have an investment policy statement. By incorporating ESG considerations into this statement and into the investment management contract, a clear link is established between the duties of the fund trustees and the asset manager.

The duty in respect of ESG, says the report, “has to be weighed with or against other fiduciary duties, such as the duty of fairness to all beneficiaries, the duty to act in the best (not necessarily short-term financial interests) of the beneficiaries, the duty to diversify to hedge risks, and the duty of prudence”.