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To change investors' priorities, first change the law

To change investors' priorities, first change the law Ian Fraser

The UK government desperately wants investors and asset managers to act as its front line in the war against ‘crony capitalism’, irresponsible management and fat cat pay. Investors, unenthusiastic about performing such a role even at the best of times, are warning they are probably unable to unless the law is changed.

The current legal framework underpins a short-termist, devil-take-the-hindmost, mindset, which worships rapid short-term profits growth but which can be detrimental to investors' long-term wealth. It encourages  investors, and the corporations in which they invest, to pursue investment approaches that focus on short-term gains with little regard to longer-term performance or the sustainability of their strategies (the pre-crisis behavior of out-of-control banks like HBOS and RBS was where the disease, exacerbated by a myopic pursuit of inappropriate metrics (EPS/RoE), became most pronounced.)

Investors including Aviva Investors, Jupiter Asset Management, Hermes Fund Managers and other bodies inclluding UNEP, ACCA and FairPensions now believe it's time for a change and are calling on the government to tighten up the definition of "fiduciary duty" which is currently wide open to misinterpretation along Friedman-esque lines and hence abuse. They have written a letter to this effect to The Times (non-paywall version).  The signatories, who also include David Pitt-Watson of the UNEP's Finance Initiative and Alan MacDougall of Pensions Investment Research Consultants, wrote:

[Investors'] duty to act in the best interests of savers is [currently] widely seen as a duty to focus solely on the maximisation of short-term returns, ignoring anything that cannot immediately be monetised. The folly of such an approach has been amply demonstrated by the banking crisis .... If politicians are serious about encouraging a more far-sighted and responsible capitalism, they must remove this perceived legal barrier. If the hopes being pinned on investors are to be fulfilled, attention must turn to an aspect of the law which is pushing in precisely the wrong direction.”

The letter to the Murdoch-owned Thunderer coincides with a new report from FairPensions, which campaigns for transparency and accountability in finance.  In its Enlightened Shareholder report, published on March 14, FairPensions suggests that efforts to use shareholder activism as a battering ram to introduce a more responsible form of capitalism in the UK are doomed to fail unless legal misunderstandings are corrected. The report, which follows FairPensions groundbreaking Rediscovering Fidicuary Duty report published a year ago in March 2011, argues that an obsession with short-term profits growth causes dangerous blind spots for longer-term performance, stewardship, environmental and social issues, and impacts on the wider economy. The report concludes by saying:

“There is an urgent need to reclaim fiduciary duty from the prevailing fixation on maximising short-term returns and to refocus it on sustainable wealth creation.”

The report, launched in the Houses of Parliament with a keynote address  from Professor John Kay (who is leading a review of equity markets for the UK government), argues that fiduciaries must be empowered to consider the broader impacts of their investment decisions on beneficiaries’ future spending power or quality of life, as long as this does not compromise investment performance. “Pension investments do not exist in a vacuum, but are a means to securing a decent retirement,” the report argues.

Usefully the report also lays down some detailed proposals for legislative clarification, modelled on directors’ duties under the Companies Act 2006. It suggests that the Act’s attempt to embed "enlightened shareholder value" into UK company law missed the mark as it failed to address the common misapprehension that fiduciary shareholders are "legally obliged to be unenlightened".

Catherine Howarth, chief executive of FairPensions, said:

“The idea that the law requires those managing other people’s money to adopt ‘tunnel vision’ is inaccurate and outdated, yet remains deeply entrenched. This state of affairs serves neither savers nor the wider economy. By clarifying that fiduciaries are permitted to consider a wider range of factors, our proposals would bring shareholders’ duties into line with company directors’ duties, enabling fiduciaries to better serve savers’ long-term interests.”

Saker Nusseibeh, acting chief executive of Hermes Funds Managers, said:

“It is sad to note that the dysfunction in the system has got to such a stage that we are finding it difficult to define what fiduciary duty, which is self-evident, should mean.”

Further reading on investors' fiduciary duty and problems with finance's intermediated model

Tags: ACCA , Aviva Investors , Catherine Howarth , corporate social responsibility , environmental and social governance , FairPensions , fiduciary duties , HBOS , Hermes Fund Managers , John Kay , Jupiter Asset Management , RBS , Saker Nusseibeh , socially responsible investing , socially responsible investment , UNEP
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