Transaction costs should be in charge cap – Law Commission

Leaving transaction costs outside the charge cap has created an incentive for fund managers to increase portfolio turnover says the Law Commission.

Publishing its report into fiduciary duties today, the Law Commission recommended the Department for Work and Pensions should include transaction charges within the charge cap in its 2017 review. It also says monies received in relation to stock lending should be included within the charge cap.

The Law Commission has also called for a statutory duty to be placed on members of independence governance committees of contract-based arrangements due to be set up before next April, requiring them to act, with reasonable care, and skill in members’ interests.

The Department for Business, Innovation and Skills and the DWP asked the Law Commission to consider how fiduciary duties currently apply to those working in financial markets, and to clarify how far those who invest on behalf of others may take account of factors such as social and environmental impact and ethical standards.

The report clarifies that pension fund trustees do not have to “maximise returns” in the short-term at the expense of risks over the longer term. It concludes that trustees should take into account factors which are financially material to the performance of an investment. Where trustees think ethical or environmental, social or governance (ESG) issues are financially material they should take them into account.

It also argues that, whilst the pursuit of a financial return should be the predominant concern of pension trustees, the law is sufficiently flexible to allow other, subordinate, concerns to be taken into account. The law permits trustees to make investment decisions that are based on non-financial factors, provided that they have good reason to think that scheme members share the concern and there is no risk of significant financial detriment to the fund.

A Law Commission spokesperson says: “The Government is introducing a charge cap for default funds in schemes used for auto-enrolment in April 2015. This cap will not apply to transaction costs. We think that there is a possibility that this may create inappropriate incentives to trade. We recommend that, as part of its review of the charge cap in 2017, the Government should specifically consider whether the design of the cap has incentivised trading over long-term investment.

“We also considered some of the issues that arise with regards to intermediaries within the investment chain. We recommend that stock lending fees should also be considered as part of the Government’s review of the charge cap in 2017. We also recommend the Government reviews the current operation of the system of intermediated shareholding, with a view to taking the lead in negotiating solutions at a European or international level.”

NAPF head of investment affairs Paul Lee says: “The Law Commission does not agree with John Kay, whose review suggested that fiduciary duty should not be varied by contractual terms. If the Government takes the Commission’s advice, this means that investment managers working for trust-based schemes will only face a fiduciary obligation to the extent that their contract explicitly requires it. The NAPF anticipates that over time this will lead to a significant reassessment of the contractual mandates between pension schemes and investment managers to ensure that members’ best interests are properly held in mind throughout the investment chain.

“A NAPF survey earlier this year showed that the top six consultancies account for around 70 per cent of the schemes we surveyed – meaning a great deal of influence sits in the hands of a few consultants in the largest consultancies.  So it is interesting to note that the Law Commission indicates investment consultants may need to be regulated in the future.”