The growth of Bitcoin since its invention in 2008 has largely been fuelled by tech-savvy private investors. Until recently, corporates and institutional investors have tended to stay out of the cryptocurrency market for a variety of reasons, not least because it is a volatile, nascent asset class with little or no regulation.
However, the market has developed steadily in recent years. The price of one Bitcoin has risen from £4,000 in mid-March 2020 to over £45,000 for parts of April 2021, while the broader cryptocurrency market capitalisation is now in excess of £1 trillion.
This growth has been partly fuelled by crytocurrencies' broader acceptance by market participants, leading to an increased institutional and corporate interest in investing. For example, large listed US corporates such as Tesla, Square and Microstrategy have recently allocated billions of dollars of treasury assets to holding Bitcoin, while asset managers such as Fidelity and JP Morgan have applied to set up a Bitcoin fund.
However, any increased enthusiasm for investing in cryptocurrencies must be tempered with an awareness of the risks. The Financial Conduct Authority recently published an article on investing in cryptocurrencies, in which it stated that "Investing in cryptoassets … generally involves taking very high risks with investors' money. If consumers invest in these types of product, they should be prepared to lose all their money."
Legal issues for pension trustees
Some have speculated whether defined benefit pension scheme trustees could invest a portion of their portfolio into Bitcoin or other cryptocurrencies, citing the potential for very significant returns and the potential ability to hedge against certain risks (for example, inflation). However, before "dipping their toes" in this market, there are a number of legal obstacles trustees will need to overcome.
1. Do they have the power?
The first thing trustees should consider is whether they can invest in this way – in other words, do they have the power to do so? Trustees should check the terms of the investment power in their scheme rules as well as consider any statutory powers. Investment powers in rules are typically drafted in wide terms, and trustees also benefit from a broad statutory investment power in section 34(1) of the Pensions Act 1995. However, the rules may not explicitly permit investing in cryptocurrencies given it is a relatively new asset class.
If cryptocurrencies aren't explicitly listed in the rules as an acceptable form of investment, trustees may feel more comfortable amending their rules to make the position clear. This is likely to involve getting the agreement of the employer, as amendment powers typically provide for employer and trustee agreement.
2. Acting in members' best interests and taking advice
Assuming they do have the power to invest in cryptocurrencies, trustees should consider whether they would be acting in accordance with their fiduciary duties in making this type of investment. In making investments, pension trustees must take such care as an ordinary prudent person would take if he invested "for the benefit of other people for whom he felt morally bound to provide". Trustees must also invest in members' best financial interests.
To assist them in making this decision, trustees are required to take written professional investment advice (section 36(3) of the Pensions Act 1995). Trustees should ensure the investment advice covers the environmental, social and governance impact of investing in cryptocurrencies – particuarly the energy-intensive "mining" process that is undertaken for certain cryptocurrencies – in light of new laws and the increasing focus on trustees taking into account climate change factors when investing.
3. Trustee policies
Trustees should consider whether investing in cryptocurrencies would be consistent with their policies – such as their statement of investment principles (SIP) and "integrated risk management" (IRM) policy. If their SIP needed to be amended, this would require trustees to consult with the employer.
Under the IRM policy, trustees would consider the investment risks in conjunction with covenant and funding risks. For example, trustees may consider it acceptable to take a larger investment risk if the risk is underwritten by a strong employer covenant. The converse would apply if the covenant was weak and/or the scheme was poorly funded.
4. Investing in regulated markets
Trustees should also be aware that, under pension investment regulations, they must ensure that the "assets of the scheme … consist predominantly of investments admitted to trading on regulated markets" and that "investment in assets which are not admitted to trading on such markets must … be kept to a prudent level".
Given the cryptocurrency market is not yet regulated, trustees could only currently allocate a relatively modest amount of their overall portfolio to direct investments into cryptocurrencies.
5. Custody issues
Trustees would also need to consider how they would ensure safe custody of any cryptocurrencies they purchased and, in particular, who would hold the "private keys".
It's possible that trustees' existing investment managers could offer a custody service, but this would need to be carefully scrutinised. One of the main risks of investing in cryptocurrencies is the fact that if the private key is lost, the cryptocurrency can no longer be accessed.
If a suitable custody solution cannot be found to allow trustees to hold cryptocurrencies directly, but they still wanted exposure to the underlying cryptocurrency value, then one possibility would be to invest in a cryptocurrency fund or investment trust traded on a regulated market.
Osborne Clarke comment
Given the potential for institutional adoption into what is still a relatively new asset class, 2021 promises to be an interesting year for cryptocurrencies. Trustees might like to follow developments. However, the significant risks involved mean that great care is needed. Among other things, trustees would need to take, and make sure they fully understand and are comfortable with, professional investment advice.
If you would like to discuss any of these issues, please contact one of our experts below, or get in touch with your usual Osborne Clarke contact.