ESG will undoubtedly remain a hot topic of 2022 across all industries, but it is far from new to those involved with the day-to-day running of pension schemes.
Trustees of UK occupational pension schemes have been required by regulations since 2000 to record their approach, if they have one, to the ethical, social, and environmental impact of their investment choices. Since then, ESG has worked its way steadily up the social agenda, and role of pension schemes has expanded over the same time.
In the broadest terms, pension schemes rely on investments to produce the income they need to pay benefits to members in retirement. Some of the UK’s largest defined benefit occupational pension schemes are institutional investors with billions of pounds in assets invested in the UK and global economy. It is no surprise then that the government has legislated and regulated to ensure that ESG factors are included in pension scheme investment strategies to help drive forward the ESG agenda.
Greater engagement
As a result, trustees have become increasingly engaged in ESG matters – but it is not just because the law requires them to. Pension schemes do not exist in a vacuum and, as the general public also becomes increasingly engaged with ESG, trustees have been obliged to pay more attention to the impact of the collective consciousness on their schemes. For a growing number of people, the way in which their pension savings are invested is an important factor, and in recent years trustees have seen more interest in ESG-friendly investment options from their members.
None of this means that trustees – or other pension providers – are free to make investment decisions based on personal views or the perceived morality of certain investments. Trustees of occupational pension schemes have wide statutory investment powers but they are also subject to onerous investment duties. When it comes to ESG, those duties can often feel at odds with one another: a duty to consider ESG friendly investments, which might not always generate the same returns as their non-ESG counterparts, might seem contradictory to a duty to act in the best financial interests of members.
Understanding the investment obligations placed on trustees can be a difficult task in itself and balancing these competing obligations can be even less clear cut, especially when you consider that many trustees are volunteers, not pensions or investment specialists. Trustees are required to take, and understand, professional investment advice to help them look beyond general or personal perceptions of what might be deemed ‘good’ and ‘bad’ investment options, and consider carefully whether the ESG matter in question is a financially material consideration for their scheme.
“In recent years trustees have seen more interest in ESG-friendly investment options from their members.
Held to account
Careful consideration alone, however, is not enough. Trustees are held to account by a regulatory requirement to include their policy on financially material ESG matters in publicly available investment statements – and, if they have a policy on ESG considerations that are not financially material, they must include that too.
A good example of this consideration process in practice is tobacco. In 2010, the government set up the National Employment Savings Trust (NEST). This was to facilitate automatic enrolment, a scheme under which eligible jobholders can be automatically put into membership of a pension scheme by their employer as part of the initiative to encourage earners to save for retirement. NEST is used by thousands of UK employers and, at the end of 2021, it had 10.8m members and over £23 billion net assets under management. It is a huge scheme with investment clout.
In June 2019, NEST announced that it would be removing tobacco from its entire investment portfolio. That decision was not, however, based on any judgment on the part of the people in charge at NEST that smoking has disastrous health or social consequences. Rather, it was based on the calculation that stricter worldwide regulation of tobacco products, aggressive government-led legal action against tobacco companies and falling smoking rates made tobacco a poor investment for NEST’s members. Of course, those factors are all driven by these and other well-known problems within the tobacco industry, but those problems alone might not have been sufficient drivers for the investment decision. NEST had to go further and consider the impact of these problems on the future viability of tobacco related investments for the scheme.
The move away from tobacco was a significant financial decision for NEST which, at the time, had over £40m in tobacco-related investments. But NEST is not alone. We have helped some of our clients consider whether it is reasonable to remove tobacco-related investments from their portfolio for the same reasons, and we are starting to see similar conversations among trustees in relation to climate change and climate-related investments.
Take investment in the fossil fuel industry, for example, which is still common in pension scheme portfolios. As more viable alternatives to fossil fuels become available and the UK moves along its journey to net zero, we expect more trustees to consider whether their fossil fuel related investments remain appropriate, not least as the threat of punitive taxation may undermine the viability of the industry.
Climate change
Climate change is only one of many ESG factors. However in pensions – and elsewhere – it has in many ways become a separate, though still inextricably linked, topic. In a July 2021 consultation on climate-related reporting regulations for pension schemes, Guy Opperman, the UK pensions minister, described climate change as “the defining challenge of our time” and expressed a clear expectation that pension schemes are to act as a leading force in implementing climate-related recommendations made by the Task Force on Climate-related Disclosures. Those regulations are now in force and require the country’s largest schemes to make annual climate change disclosures, and whilst smaller schemes are not expected to comply with them (for now at least), the Pensions Regulator expects to see all schemes considering the risks and opportunities presented by climate change going forwards.
When we talk to our trustee clients about ESG, and in particular about climate change, we often hear the question “is it really our job to change the world?”. Much to their relief, the short answer is no, but the practical reality is slightly more nuanced. The Pensions Regulator’s view is that, regardless of whether they are caught by the legal requirements, trustees should exercise effective stewardship in relation to climate change, and as time goes on, more of the investment options traditionally seen in pension scheme portfolios could follow the same path as tobacco.
So, whilst trustees do not have to change the world, they cannot sit back and do nothing. Trustees must start to work proactively with their advisers – their investment consultants and their lawyers – to understand and consider the relevant and irrelevant factors when making ESG-related decisions.
“Pension schemes are to act as a leading force in implementing climate-related recommendations.
Disclaimer
This information is for educational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given. © Shoosmiths LLP 2024.