Environmental, social and governance investment is growing in prominence in the UK and around the world.
Given their unique position, controlling around £2.5tn in assets, pension scheme trustees have a significant role to play.
Pensions legislation and the pensions industry have been catching up with the changing investment climate, and trustees need to be aware of their ESG investment obligations.
What is changing in the pensions world?
Most pension scheme trustees already publish a statement of investment principles, providing information on their investment strategy.
For now, statements of investment principles have to explain how much (if at all) the trustees have taken into account ESG considerations in their investments.
However, this will change from October when trustees will need to explain their policies in two areas of investment decision-making.
The first being how financially material considerations, including ESG, over the appropriate time horizon – the length of time the scheme needs investments to pay out – are taken into account.
Trustees should already be thinking about financial issues for this, but the key change is that there will soon be an explicit requirement for them to include ESG factors as financial considerations – and to take a longer-term view of them.
The second being how ‘non-financial matters’ are taken into account – if at all. Non-financial matters are defined as the views of scheme members, including ESG issues and their future quality of life.
Trustees will need to set out their policy on engagement with the funds they invest in, and also to their investment managers, not only in relation to investment performance but ESG issues too.
Trustees will need to update their statement of investment principles to reflect the new requirements in legislation.
However, there is no explicit obligation for them to change their investment behaviour at the moment. Rather, they will need to engage with ESG issues and give them proper consideration.
For some trustees that is likely to have an impact on their investments, others may decide ESG investments are inappropriate for their scheme.
What will this mean in practice?
While the new legislation tells trustees what they have to think about, it does not tell them what they can do in practice. When it comes to investments, a trustee’s fundamental duty is to use their powers for their proper purposes – that is, to provide benefits to scheme members.
ESG considerations may well make up an important part of this.
For example, an energy company might be at risk of punitive regulation and taxation in the long-term as governments try to tackle climate change, or a company’s poor record on social and governance issues could result in negative publicity and harm its business.
Trustees are certainly entitled to take financial considerations like these into account in their decision-making.
Trustees will want to engage more with their investment managers, and any companies or funds they have invested in, to look for potential ESG issues.