In a recent article, professors Jill Fisch and Jeff Schwartz argue that the beneficiary primacy model – requiring pension fund trustees to maximize economic value solely for beneficiaries – fundamentally misunderstands the nature of public pension funds. They contend that public pension funds differ critically from private funds because beneficiaries receive defined benefits that do not vary with fund performance. Unlike mutual fund investors who are residual claimants, public pension beneficiaries have contractual claims to fixed payments. As the two professors note, if a public pension fund outperforms, beneficiaries have no claim to the surplus; it belongs to the government.

Their solution is as innovative as it is radical: Treat public pension funds as principals rather than intermediaries. Under their model, fund managers would owe fiduciary duties to the fund itself, not to beneficiaries. This would free managers to balance the sometimes-competing interests of multiple stakeholders – employees, taxpayers, local communities, and beneficiaries – guided by state constitutions, legislation, and investment policies. As they argue, “the political nature of public pensions is a feature, not a bug.

I will provide the English law perspective, but the UK principles also apply to some extent to Fisch and Schwartz’s U.S. law analysis. I will examine the roles and duties of pension fund trustees, because as Fisch and Schwartz recognize, public pension funds in the U.S. are typically organized as trusts.

The Current State of the Law: A Transatlantic Comparison

It has been argued that under U.S. law, the beneficiary primacy principle is a problem because, among other reasons, fund managers or pension fund trustees are not permitted to take into account ESG factors but must maximize the economic value of the fund. Fisch and Schwartz go further, arguing that this principle creates litigation risk and “delegitimizes values-based fund management decisions,” forcing fund managers to make disingenuous claims that all ESG decisions maximize returns.

But while the beneficiary primacy principle is recognized under English law, it is more nuanced. For pension fund trustees to address ESG issues, it is unnecessary and undesirable to reframe a pension fund as a principal to which trustees solely owe duties. This reframing subverts well-established tenets of trusts law and fiduciary law.

The Flexibility of Fiduciary Duties Under English Law

In my view, under English law, pension fund trustees are already legally permitted, and under certain circumstances may even be legally required, to consider ESG factors, if one of two conditions exist. First, the trustee’s mandate, as stated in the trust deed or legislation allows or requires them to consider these factors. Or second, these factors materially affect the long-term risk-adjusted returns for the beneficiaries.[1]For example, trust-based pension funds are statutorily required to take into account climate-related risks.[2]

To begin with, under English law, the fiduciary duties of pension fund trustees primarily consist of promoting the purpose for which the trust was created. This has been interpreted to require the trustees to balance returns against risks[3]; this is different from the maximization of risk-adjusted returns as stated by Fisch and Schwartz. English law generally permits fiduciary duties to be shaped or qualified by the terms of the trust deed, applicable contract or applicable legislation, such that the scope of fiduciary duties has to be interpreted to permit, and may even require, the pension fund trustees to address ESG factors.[4]

Reconciling the Cases: No Need for Judicial Contortions

Fisch and Schwartz argue that courts “contort themselves” to uphold values-based investment decisions while nominally applying the beneficiary primacy principle. They discuss cases like State of West Virginia v. Investment Management Board[5] (upholding mandatory investment in jail bonds) and Board of Trustees v. Mayor and City Council of Baltimore City[6] (upholding required divestment from South Africa) as examples where courts strain to find economic justifications for politically motivated decisions.

However, under English law, if the trust deed or legislation permits or requires the trustees to consider or even prioritize environmental, social, political, or other kinds of factors, or to make certain investments, the beneficiary primacy principle, which is part of fiduciary duties, is no obstacle at all. This is because the fiduciary duty has been molded or qualified by the trust deed or legislation.

Thus, should the facts of State of West Virginia v. Investment Management Board be decided by a UK court, the decision in that case is justifiable because the legislation has given the mandate to the state pension board to invest in jail bonds. Likewise, the decision in the Board of Trustees v. Mayor and City Council of Baltimore City is similarly justifiable because the state law requires the public pension funds to divest from companies doing business in South Africa during the apartheid era. This is because the duties of the pension fund trustees had been qualified by, or had to be interpreted in light of, state law.

The Heart of the Matter: When There Is No Clear Mandate

A real difficulty arises when there is no clear mandate, that is, when the trust deed or legislation is silent as to whether pension fund trustees can take into account ESG factors. Fisch and Schwartz argue this creates an “irresolvable and disingenuous” debate where fund managers must artificially claim that all decisions maximize returns. Their solution is to abandon the beneficiary primacy principle entirely.

One answer provided by the beneficiary primacy principle, as described by Fisch and Schwartz, is that pension fund trustees are not allowed to do so because their sole and overriding duty is to maximize the returns of their beneficiaries.

But under English law, while pension funds trustees must act in the exclusive interests of beneficiaries, this does not mean they have to maximize returns. Rather, the beneficiary primacy principle requires trustees to balance returns against risks.

The Three Levels of Risk-Return Analysis

As the 2024 UK Financial Markets Law Committee (FMLC) makes clear in its important paper, “Pension Fund Trustees and Fiduciary Duties: Decision-making in the Context of Sustainability and the Subject of Climate Change”, pension fund trustees can balance returns against risks at three levels:[7] the specific investment level,  the portfolio level, and the level of whole economies material to the pension fund.

This framework elegantly addresses many of Fisch and Schwartz’s concerns about economically targeted investments (ETIs). They explain how public pension funds have invested in local infrastructure, affordable housing, and small businesses – investments critics condemn as creating politically motivated conflicts of interest. But under the FMLC approach, these can be justified at the third level of analysis.

Thus, trustees are allowed to consider ESG or political factors to the extent they constitute material financial risks or opportunities that can affect the returns of the beneficiaries. Should a UK court decide the case of Withers v. Teachers Retirement System of New York City[8], the court is likely to affirm the decision of the fund manager because, had the pension funds not bought the state bonds, the state, which is a major contributor to and guarantor of the funds’ assets, would have become bankrupt. And this would materially affect the returns of the beneficiaries. I do not find the court’s interpretation to be particularly strained.

The ETIs, which are designed to benefit low-income earners, can be justified on this basis, because the creation of affordable housing and employment can spur economic growth, which will in turn improve the returns for the beneficiaries. This reasoning may seem tenuous. But recall that under the UK approach, as pension fund trustees can balance returns against risks at the whole economies level that are material to the fund, the ETIs can be justified on this basis. It is within the discretionary judgment of pension fund trustees to conclude that a badly performing economy, caused by unemployment, can affect the long-term risk-adjusted returns for the beneficiaries.

Beyond Financial Factors: The Two-Test Framework

Fisch and Schwartz document extensive public pension fund activism on social issues – from New York City Employees’ Retirement System’s 1992 proposal on sexual orientation discrimination at Cracker Barrel to recent fossil fuel divestments. They argue that putting beneficiaries first forces funds to make disingenuous economic arguments for these values-based decisions.

In my opinion, even if the pension fund trustees are motivated by their moral or ideological views when they make ETIs or when they consider ESG factors, they may not breach their fiduciary duty to act in the best interests of the beneficiaries. This is because under English law, taking into account non-financial factors is permissible, if two tests are met: first, trustees should have good reason to think that the beneficiaries would share the concern; and second, the decision should not involve a risk of significant financial detriment to the fund.[9]

Pushing the Boundaries: The UK Butler-Sloss Decision

What if the first test is met but not the second? Can the fiduciary still take into account and give effect to these non-financial considerations such as advancing the net-zero agenda or implementing the Paris Agreement? There may be support for an affirmative answer in a 2022 English High Court decision.

In Butler-Sloss v. Charity Commission for England and Wales[10], the trustees of two charitable organizations sought a declaration from the court that they were not in breach of their fiduciary duties by aligning their proposed investment policy with the Paris Agreement and therefore with the wishes of their respective charities, even if doing so would lead to lower returns for their beneficiaries. The goals and objectives of the investment policy were to “protect and enhance the trust’s financial returns and support its charitable objectives” and in doing so, “align its investments with the Paris Climate Agreement.”

To implement the policy, the trustees decided on an investment that had the highest percentage of green funds but there would be financial detriment in the short term, the precise amount of which the trustees could not determine. The Attorney General and Charity Commissioner took the view that the potential financial detriment would conflict with the trust’s purposes. But the court disagreed, holding that the trustees had discharged their duties and struck the right balance between giving effect to the goals and objectives of the investment policy, which included aligning investments with the Paris Agreement, and the financial detriment that would ensue.

In my view, this case suggests that English courts may defer to a fiduciary’s balance between risk-adjusted returns and non-financial considerations – even if it causes short-term financial detriment – provided that the trust’s purpose permits such investments and specifically includes these non-financial objectives. Where the trust lacks such provisions, the fiduciary must ascertain the beneficiaries’ preferences, which may be challenging.

Regulatory Guidance and Climate Disclosure

Where regulations or guidelines require or expect asset managers, asset owners, and pension fund trustees to make climate-related disclosures, the fiduciary duties of these entities – here the beneficiary primacy principle – have to be interpreted in that light.

For example, the UK Financial Conduct Authority has issued similar disclosure rules or guidelines.[11] This means that asset managers must consider climate-related risks as part of their duty to their beneficiaries to balance returns against risks. This is an example of how the common law fiduciary duties have been molded or qualified by regulation.

Why Revolution Is Unnecessary

In my view, under English law, it is unnecessary to overturn the longstanding principle that trustees owe duties only to beneficiaries. Nor is it desirable to assert the controversial claim that public pension fund trustees owes duties only to the public pension fund understood as a principal. It is difficult to defend the claim that the public pension fund is a principal when, unlike a company, it is not conferred a separate legal personality by the law.

Fisch and Schwartz’s reconceptualization, while intellectually bold, would require fundamental changes to well-established trust law principles. More concerningly, completely severing the link between fund managers and beneficiaries could reduce accountability and potentially enable the political manipulation they elsewhere acknowledge – such as when Louisiana’s State Treasurer stopped investing with BlackRock to protect the fossil fuel industry.

The English law approach achieves most of their legitimate objectives – enabling ESG consideration, supporting local investments, and reflecting public values – while maintaining crucial protections against self-dealing and mismanagement. It recognizes that pension fund trustees operate within a framework shaped by legislation, regulation, and trust documents, but preserves the fundamental principle that they must act in their beneficiaries’ best interests, properly understood.

ENDNOTES

[1] “Pension Funds and Social Investment” (Law Com No 374) 22 June 2017, Paragraph 1.13 of Appendix 1.

[2] See eg, Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021.

[3]  Supra n 1.

[4]  The English authority for the proposition that fiduciary duties can be contractually modified is Kelly v. Cooper [1993] A.C. 205; see also Henderson v Merrett Syndicates Ltd [1995] 2 AC 145 at 206. For an example of pension fund managers’ duties being shaped by regulation, see Loosemore v Financial Concepts [2001] Lloyd’s Rep PN 235.

[5] State ex rel. W. Va. Reg’l Jail & Corr. Facility Auth. v. W. Va. Inv. Mgmt. Bd., 508 S.E.2d 130 (W. Va. 1998).

[6] Bd. of Trs. v. Mayor & City Council of Balt. City, 562 A.2d 720 (Md. App. Ct. 1989).

[7] Paragraph 6.6, https://fmlc.org/wp-content/uploads/2024/02/Paper-Pension-Fund-Trustees-and-Fiduciary-Duties-Decision-making-in-the-context-of-Sustainability-and-the-subject-of-Climate-Change-6-February-2024.pdf.

[8] Withers v. Tchrs.’ Ret. Sys. of New York City, 447 F. Supp. 1248 (S.D.N.Y. 1978).

[9] R (on the application of Palestine Solidarity Campaign Ltd and another) v Secretary of State for Housing, Communities and Local Government [2020] UKSC 16 at [43].

[10] [2022] EWHC 974 (Ch).

[11] Financial Conduct Authority (FCA), Policy Statement 21/24, December 2021.

This post comes to us from Ernest Lim, vice dean and professor of law at the National University of Singapore.