Modernizing Pension Fund Legal Standards for the 21. Century

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Finance think tank says financial system rethink depends on pension fund reform; issues six-point plan

(11 February 2009)

The internationally respected Network for Sustainable Financial Markets today released a paper, “Modernizing Pension Fund Legal Standards for the 21st Century,” with recommendations for fundamental changes to the pensions system.

The paper argues that, with economies around the world in crisis and governments working on redesign of the global financial system, the issue of pension fund reform has become critical. Yet this central plank of the world financial order is escaping scrutiny.

Keith Johnson, co-author of the report, said “Pension funds have grown to be a massive part of the global financial system. In the US, for example, institutional investors, with over $10 trillion in pension fund assets alone, now own up to 76% of the stock market.”

“The value of pension fund equity holdings in the United States fell by $4 trillion over the past year. Despite their importance, the impact of pension funds and fund investment managers on the financial markets has not been sufficiently discussed.”

“For example, pension funds have been encouraged to operate using interpretations of fiduciary duty stuck in a mid-20th century view of their impact on the economy.  Pension fund trustees are required to invest like other pension funds and pursue copycat strategies.  Given the growth in pension fund assets, this now has a major effect on the economy.”

Mr. Johnson asserts that these outdated interpretations of fiduciary duty have amplified natural investor ‘herding’ behavior around the same investment practices. As a result, pension funds have all moved toward shorter-term investment horizons that are poorly aligned with their long-term obligations to participants.

He said: “Research shows there is industry-wide pressure from pension funds and other institutional investors on corporate managers to deliver short-term investment results. This pressure has become so strong that nearly 80 percent of corporate managers say they would sacrifice future economic value to manage short-term earnings and meet investor expectations.”

“This is an incredibly destructive force and has contributed directly to the collapse of financial markets, as financial institutions and operating companies take on excess leverage and engage in financial engineering to meet short-term revenue expectations.”

“It results in lemming-like behavior by pension funds, exaggerates market volatility and affects the financial health of corporations. Yet the performance of pension funds is directly tied to stability and growth of the corporate sector and to stability of the broader economy. Companies need investors with a more balanced approach to the markets and pension funds need sound companies that can deliver sustainable results.”

“Pension fund investment practices now not only determine what sort of retirement we will have; they also influence the global economy.”

Co-author Dr. Frank Jan de Graaf said “Pension funds are central to health of the financial system and are a primary source of capital. In some countries, the aggregate value of pension fund assets even exceeds the Gross Domestic Product.”

“As major market players, pension funds now have to look at systemic risks to investments that lie outside of what has traditionally been quantified by the industry. This includes risks to the wider economy in which they operate. It requires consideration of how the economy as a whole is working, as well as long-term factors like exposure to climate change.”

Some professional bodies are recognizing this. The Chartered Financial Analysts Institute, for example, advises that pension fund boards must consider “all relevant risk and value factors,” which “may include environmental, social, and corporate governance issues.”

Dr. de Graaf and Mr. Johnson point out that not attending to longer-term, systemic risks could raise questions about compliance with the fiduciary duty of impartiality, by pushing costs into the future and favoring generation of current earnings over longer-term capital growth needs of younger participants. Dr de Graaf emphasizes, “We have to modernize the outdated, narrow understanding of fiduciary duty to reflect reality of the 21st century and impartially serve the interests of all fund participants.”

Mr. Johnson notes, “One of the first items to be revisited should be the 11th hour spin attempted by the Bush administration regarding interpretation of fiduciary duty in the US for voting proxies and sponsoring shareholder resolutions. Two Interpretive Bulletins issued in 2008 by the US Department of Labor imply that fiduciaries can only justify shareholder activism to increase immediate returns at the company involved. That narrow view ignores longer-term portfolio-wide benefits and disregards risk mitigation, which is the kind of thinking that directly contributed to the current global crisis.”

The report recommends six immediate changes to pension systems in areas such as regulatory interpretation of fiduciary duty, changing investment manager incentive structures, making cost structures more transparent, and actively promoting best fund governance practices.   

The full paper is available from

This paper will appear in the Spring 2009 issue of the Rotman International Journal of Pension Management published jointly by the Rotman International Centre for Pension Management and University of Toronto Press.


For more information contact:  

Mr. Keith Johnson, USA                                Dr Frank Jan de Graaf, Netherlands,                                   

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Mr. Johnson is Program Director for the International Corporate Governance Initiative at the University of Wisconsin Law School and was previously Chief Legal Officer at the State of Wisconsin Investment Board.  Dr. de Graaf is a Professor of International Business at Hanze University of Applied Sciences and was formerly an Advisor for Responsible Investment at PGGM Investments in the Netherlands.