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Authored by
Bella Landymore

What is the purpose of money? It powers businesses, infrastructure, and governments that ultimately shape the world around us now and for future generations. That probably sounds obvious, but it isn’t always front-and-centre of how most of those managing money make their investment decisions. 

Managing the savings of 15.9 million people

In the UK, pension schemes are responsible for managing the savings of 15.9 million people. The laws governing their investment decisions are called fiduciary duties. And many interpret fiduciary duties as “maximising financial returns” – which can be extended to, “money for money’s sake”. So, there can be a disconnect between the purpose of a pension scheme and its real-world impact. In a world facing existential climate and humanitarian crises, this disconnect becomes particularly acute. We might ask, what is the point of short-term financial gains generated by investments creating and prospering from an unsustainable system? 

It is therefore significant that yesterday, a committee of the UK’s top financial lawyers published a paper that helps navigate this issue. Specifically, why and how the real-world impacts of sustainability and climate change should factor into pension schemes’ decisions. There is a lot to process in the paper by the Financial Markets Law Committee (FMLC), so I’ll highlight the key points – points that I think start to help shift the very paradigm in which investment decisions are made. 

Putting savers’ interest first

Firstly, the paper clarifies that fiduciary duties are a range of duties that those managing a pension scheme owe to the savers in their scheme. They include loyalty, which means putting their savers’ interests first. They also include managing the scheme ‘properly and lawfully’ in order to pay pensions. Neither of these duties mean “maximise financial returns”. 

Secondly, the paper addresses which matters are relevant to investment decisions. In law, the line is drawn between ‘financial’ versus ‘non-financial’ factors, with the latter usually seen as not relevant. The paper clarifies that what makes a factor financial or non-financial depends on the motive of the person weighing it up, not the factor itself. This means the scope of relevant factors is very broad, because matters that could be judged financial are very wide ranging. Indeed, what may initially appear ‘non-financial’ can become financial due to changes in the understanding of risk and reward over time. 

Sustainability is a financial matter

These considerations are particularly pertinent in the case of sustainability and climate matters. The paper makes clear: all pension schemes should consider sustainability because sustainability is a financial matter. 

This brings us to the third key point: prevailing uncertainty about the scale and breadth of the impacts of climate change, and diverging laws and regulations, are not excuses for disregarding them. Financial factors are relevant, even if they can’t be measured precisely. Time horizons and the nature of the effects of climate change may make it difficult to attribute probabilities. But if the matter is material – meaning that it could have a significant impact on an investment decision – it should be taken into account. Such risks can be expressed words rather than numbers. 

What does this mean for pensions?

What does the paper say this means for pension schemes? They are placed firmly as participants in much wider financial and economic systems – not separate from them. They should consider how investments and companies address sustainability risks and returns and how businesses and governments are exposed to global dispute or litigation risk. And they need to consider economic or systemic climate change-related issues, including physical and transition risks.  

Most importantly, it means they can say no to investments with shorter term gains where they create longer term sustainability risks, and they can choose to invest for positive sustainability impact. 

Fiduciary duties aligned with the needs of the world

What happens next is crucial. At the Impact Investing Institute, we work to help investors put their money to use in ways that support and accelerate a better world. The insights provided by the FMLC on the vexed issue of fiduciary duties are a significant step forward. We would like to see policy makers and regulators codify them in guidance. And those working in and advising pensions need to make practical use of and promote them. Our current, flawed frameworks for investment decision making are deeply entrenched and a concerted effort is needed on all sides to define, communicate, and embed new frameworks that align the evolving needs of our rapidly changing world.