Investment for a sustainable and inclusive economy
—Proposed changes to UK law

Report by Charles Seaford
January 2019

This paper is a result of an inquiry into sustainability and investment, carried out by Charles Seaford. It is part of a portfolio of activities within CUSP. For more details on our work on finance, please see www.cusp.ac.uk/finance. The report can be downloaded in pdf.

Executive summary

The problem

There are potential reforms to the investment industry that would make it more likely that capitalism delivers sustainable and inclusive prosperity. They would do so by making it easier for shareholders to put pressure on company managers to take account of the public good[1] and to adopt a long-term focus when making business decisions. The public good includes such things as a cohesive society, increased prosperity and environmental stability, all of which are likely to help increase portfolio values over the long-term as well as advance the other interests of shareholders and those saving for or receiving a pension (‘savers’). The reforms would also help advance the objectives set out in both the Conservative and Labour manifestos for the 2017 election. They are in line with some of the more progressive thinking in the investment industry.

At the moment, company managers often fail to take account of the public good even when doing so would be in the interest of savers, and they sometimes sacrifice long-term financial success in order to achieve short-term financial success (for example by cutting the R&D budget). This is largely because of the nature of their incentives, which are often linked to profit performance and the share price. Investment intermediaries such as asset managers already have the tools to change these incentives and make them more aligned with the interests of the savers on whose behalf they work. However, they themselves lack incentives to use these tools. This is largely because savers have no power.

Proposed solution

We propose increasing savers’ power by specifying in more detail the nature of investment intermediaries’ fiduciary duty[2] to serve their best interests. This duty already exists, but despite clarification from the Law Commission in 2014, what constitutes ‘best interests’ is still too vague to drive change. Custom and practice prevails. If, however, activist saver groups can litigate when the duty is neglected—much more likely if it is more precisely specified—then a new, strong incentive for change is created.

To achieve this, we recommend that Parliament makes it explicit that trustees and other investment intermediaries have a duty to their savers to exercise such influence as they have to advance (a) the long-term financial success of investee companies, (b) those aspects of the public good likely to enhance portfolio value, (c) after consultation with their savers, other aspects of the public good that are clearly in their interests, and (d) any ethical objectives savers may have. Parliament should also make explicit that this will require intermediaries to act as ‘stewards’, that is to engage with companies and exercise voting rights. Parliament should also make explicit the kinds of procedure needed to decide which aspect of the public good are to be advanced.

How this goes beyond recent regulatory changes

The Department for Work and Pensions has recently laid new regulations before Parliament designed to improve pension fund trustees’ accountability by creating various obligations to report to savers. This is progress, but given the inertia in the industry, these are unlikely to change intermediary behaviour to anything like the degree needed. Also, they ignore the contribution that companies can make to aspects of the public good that in turn contribute to portfolio value and other drivers of savers’ material wellbeing. And they don’t take full account of the preference many savers have for an ethical form of capitalism. It is at these broader levels that the opportunity to use the investment system to help capitalism deliver sustainable and inclusive prosperity mainly exists.

Complementary changes needed

To respond to this opportunity, to perform their newly specified duty, intermediaries will need new kinds of information and new capabilities. Much work is being done on information, but the problem is lack of common standards, and government should facilitate these. It should also encourage provision and take up of suitable training. In addition, asset owners will be better equipped to respond to the new duty, and the pressure from savers it creates, if they are large enough to do what is needed, and if they have saver representation in their governance structure. Government should continue to encourage consolidation and strengthen asset owner governance rules. Finally, regulatory barriers to the new duty should be removed, and any necessary changes to regulator mandates made.

The message for politicians

Delivering an effective investment industry has been largely delegated by politicians to regulatory bodies, on the assumption that the measures needed have little relevance to wider social and economic issues. The argument of this paper implies that this assumption is false, and that therefore politicians could usefully consider what may have been seen as purely technocratic issues.

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[1] By the ‘public good’ we mean the wellbeing of the economy and society as a whole.
[2] And where necessary stipulating that intermediaries are fiduciaries