The Pensions Regulator says stop feeding your elephant peanuts!

No, The Pensions Regulator’s remit has not been extended to cover zoos.

Rather in her blog posting last week, Louise Davey, Director of Regulatory Policy, Analysis and Advice at TPR, raised concerns that pension scheme trustees are not paying enough attention to the climate change elephant in the room.

Specifically, TPR is concerned that some trustees are not playing their part in supporting the shifts in practice needed to address climate change and the benefits of considering broader ESG issues in investment decisions. TPR is looking for trustees to devote more time to considering these issues, and as a result have well thought through policies that have real-world effect on investment strategies.

Put simply, TPR is demonstrating that the 1990s approach of “we have no ESG view” is not good enough.  In addition, they have made it clear that by having a generic, vague ESG section in their statement of investment principles, and little evidence of active thinking in formulating the policy or evidence of regular action to ensure the policy is being met in their Implementation statements, trustees are failing in their duties.

Specifically, the blog provided details of TPR’s planned regulator initiative in respect of SIPs and ISs.  Firstly, over the summer TPR will be checking that all trustees who are required to publish their SIPs and ISs have done so correctly.  Secondly, starting in the autumn, the content of a cross-section of SIPs and ISs will be reviewed against the DWP’s guidance from June 2022, in respect of stewardship and ESG factors. The review will lead to publication of best practice guidance, which I expect many trustees will welcome given how complex and wide-ranging ESG issues can easily become.

The blog makes it clear that TPR will take enforcement action against trustees who are not deemed to be doing enough.  So, it’s time to stop feeding the ESG elephant peanuts, and time to step up to the ESG challenge.

Now that may seem like a mammoth task!

So where do trustees start? Well obviously, the easy win is to make sure their existing SIPs and ISs are published correctly.  Trustees of pension schemes with more than 100 members, including pensioners receiving insured annuities, must make their SIPs and ISs available online to all members.  This is low hanging fruit to feed your ESG elephant.

Trustees can then turn their attention to improving the content of their SIPs. To avoid the use of generic, vague policies, trustees could undertake an exercise to document their ESG beliefs, concerns and priorities.  There is merit in doing this individually at first, as everyone’s principles are unique. A dashboard can then be collated, to allow common priorities to be identified and different opinions discussed and resolved.  Including the scheme sponsor in these exercises can ensure alignment with their beliefs, which are often a reflection of their employees’ beliefs – many of whom will be members.

This exercise should assist trustees in documenting their beliefs and priorities for inclusion in their SIPs, or potentially a standalone ESG policy.  Trustees can then identify the immediate and regular actions that must be taken to ensure ongoing compliance with their policies.

Immediate actions are likely to include a review of investment strategy, including the choice of assets and asset managers, each manager’s investment objectives, limits and exclusions, as well as their ESG policies including voting and stewardship.  Trustees may also wish to consider whether there are any direct actions they can take – such as carbon offsetting – in respect of their own meetings and reporting.

Ongoing actions are likely to include annual reviews of asset managers’ voting records and performance against ESG targets.  Again, these exercises could be extended to include the trustees’ own activities.  Future investment strategy reviews and asset manager selection exercises should include scoring against the trustees’ ESG requirements.

Trustees do need to be pragmatic; it is too easy to create an ESG policy that is not practicable.  There needs to be an understanding that compromises may be necessary.  Whilst trustees may have hard exclusions that they would like to apply such as weapons manufacturers, other ESG areas may require more nuance.  This could mean having a minimum standard for each main ESG factor, which can be combined with a scoring system, to ensure that investment strategies and appointed asset managers comply with hard exclusions and trustees’ minimum standards, and achieve the best overall scoring across all ESG factors.

Consideration will need to be given to what ESG factors mean in practice – how are they defined?  For example, does a hard exclusion of weapons manufacturers apply to manufacturers of weapons’ electronic components, or even government bonds – given that governments fund weapons manufacturing and use weapons?  Having an anti-derivatives view can affect the ability to hedge currency and interest rate risks, and increase trading costs.

This need for pragmatism and compromise will be most felt by smaller schemes required to invest in mutual funds, particularly if they identify more esoteric ESG priorities.

In addition, if trustees are actively working towards buying out liabilities, they may consider that it would not be appropriate to incur the costs of reshaping their investment strategy, to take ESG risks and opportunities into account. But perhaps consideration of ESG factors could be included in the selection criteria for their buyout provider?

Clearly we’d expect TPR to understand these practical compromises; the important thing for trustees is to demonstrate that due consideration has been taken, and that decisions and ongoing processes are well-documented and enacted with evidence.

For some time now, TPR has expected trustees’ engagement with members to be closer than historic norms. Trustees considering members’ views when setting their ESG policies is an obvious example of positive member engagement, and is highlighted in the DWP’s guidance from last year.  To keep this exercise manageable, trustees could invite member feedback when publishing their SIPs and ISs, and make it easy for feedback to be provided. They could also ensure consideration of suggestions and questions received as part of regular maintenance and reviews of their policies.

Scheme sponsors will be concerned about the additional cost of strengthening ESG governance, especially for closed schemes that they already see as white elephants. But as TPR’s blog rightly points out, there’s a carrot to motivate trustees and sponsors, as well as the regulatory stick.

A decade ago, socially responsible investing was a fringe strategy. It was seen as a financial compromise for those with strong beliefs.  However, with ESG concerns becoming mainstream and influencing government policies, corporate and consumer behaviour, not only are there potentially better returns from ESG investing, with increasing risks posed by avoiding it, it is possible that the return divergence between ESG and non-ESG investing could widen.  Trustees and sponsors will want to be on the right side.

The Pensions Regulator has issued a call to action, and trustees should take heed.  Make time now to start looking after your ESG elephant.  It’s an opportunity to benefit from the return potential carrot and avoid being hit with the regulatory stick.