Will 2020 be the year when ESG investing finally comes of age?
26 Feb 2020
The need to address Climate Change has never been so urgent or so pressing. Hardly a day goes by without news of some new climate emergency, be it melting ice-caps, wildfires in Australia or deforestation in the Amazonian jungle. The list gets longer and longer. For pension fund trustees grappling with the subject of climate change, and how they apply this to ensuring the best possible outcomes for their members, it can sometimes seem an overwhelming prospect. But as an industry we need to get up to speed - and quickly.
At CACEIS, we recently carried out a survey of UK pension funds and their attitudes towards Environmental, Social and Governance (ESG) factors in their portfolios. On a positive note, over 55% of respondents replied that exposure to ESG-related investments will increase significantly over the next five years. However, 43% of respondents felt that they didn’t currently have the right tools to monitor and report on their scheme’s ESG policy. Perhaps most worryingly of all, only 27% of survey respondents felt they were familiar with climate change-related risks. And a similar number of respondents (26%) found getting access to the right information to help them with their scheme’s ESG policy was a challenge.
In another recent survey, the UK Sustainable Investment & Finance Association (UKSIF) revealed that the majority of UK pension schemes believe that ESG issues, including climate change, will have a negative impact on their portfolios. The UK-based think tank went on to observe that most pension schemes had adopted ‘thin and non-committal’ policies to manage environmental risks and many had yet to comply with the minimum legal requirements. If UKSIF’s findings are correct, pension funds will have to move quickly to make up for lost time.
Similar findings are evident at an international level as well. Many believe that governments and industries are simply not moving quickly enough. A Global Carbon Tax, for example, is still a long way off, although last October The International Monetary Fund stepped in, calling for greater fiscal policies to curb climate change. But while China, India and the US remain amongst the largest users of fossil fuels, change is unlikely to come quickly.
At a more granular level, meanwhile, pension funds fret that providers of ESG data are too often inconsistent, leaving them confused about how they should apply it. This makes it inordinately difficult to monitor and manage their asset managers on a consistent basis. Indeed, we believe that ESG data needs far greater consistency and alignment across sectors and regions so that trustees fully understand it and have confidence in its application.
Since last October, trustees are now legally obliged to consider the long-term risks and opportunities of the ESG factors in their portfolios – and they are required to explain their policies in their Statement of Investment Principles (SIP). Furthermore, if trustees choose to disregard long-terms risks or opportunities from ESG, climate change and stewardship factors, they will need to explain why this doesn’t harm either the investment returns or outcomes for their members.
So what steps should trustees take to ensure they meet the new regulatory requirements and their fiduciary duties as trustees?
Education, Education, Education
To echo Prime Minister Tony Blair’s mantra back in the 1990s, more education is a vital first step. Today, trustees need to know more than previous generations and they have far more complicated issues to wrestle with. One solution might be a well-tailored educational programme. This can go a long way to increasing a trustee’s understanding of ESG and climate change issues. Sometimes, of course, that’s easier said than done, but trade bodies such as the Pensions & Lifetime Savings Association (PLSA) are trying to help in this area. They have created a guide that reflects the typical journey trustees take to ensure ESG, climate change and stewardship factors are understood and formalised in their Statement of Investment Principles. By way of illustration, the PSLA has created some case studies to help trustees better formulate their ESG thinking. In the hypothetical example below, an investment consultant works with a group of trustees looking after both Defined Benefit and Defined Contribution schemes with combined assets of £500 million.
First, the consultant oversees a brief training session as part of the regular trustee meeting schedule to give background information on the topic, including the applicable regulations.
Next, the consultant asks each trustee to individually complete a questionnaire to tease out their respective views on 10 core questions, including sustainability, ESG, stewardship and climate change. This is followed by a one hour workshop to discuss the results of the questionnaire, including an exploration of any differences of opinion, with a view to eventually agreeing on a collective trustee position.
Finally, the trustees regroup and draft a sustainable investment belief statement, which they can roll into their overall statement of investment beliefs. The belief statement and principles can also be used by the investment committee at future meetings in helping them to assess different investment decisions. They can also use them in their interactions with fund managers, where they’re particularly valuable in determining which managers do or don’t share similar perspectives and priorities as the trustees.
In reality, however, most pension schemes to date have merely followed their asset manager’s framework – a practice, incidentally, that’s recommended by many pension fund consultants as well. However, we believe it should be the pension scheme itself that defines the strategy not the asset manager. While The Pensions Regulator (TPR) is currently adopting a relatively light touch approach, this could change in future. Indeed, once the regulator begins to go through the SIPs, towards the end of this year, it will want to see clear evidence that schemes have implemented their ESG policies. If not, there’s a possibility that the regulator may start to fine those schemes that fail to come up to scratch. This in turn will put greater pressure on both trustees and consultants, although ultimately it should result in a more robust process.
At a more general level, we believe the new requirement to report on ESG issues and climate change is all part and parcel of good governance. It won’t be easy – sometimes it will be challenging to assess the ESG characteristics of a company and analysts may disagree on their findings – but the ultimate goal is to produce a more thoughtful, balanced assessment of the risks and opportunities in a pension scheme’s portfolio. As Melanie Cusack, a Client Director at PTL, observes the increasing focus on ESG essentially involves risk management – it’s about value rather than values – and good trustees have been doing this for years.
Last December, Mark Carney, the outgoing Governor of the Bank of England, urged pension funds to do more on climate change. He said that it was now up to every company, asset manager, pension fund and insurer to do all they could to come up with plans that minimise their own environmental impact. We believe he was right to make this observation. UK pension funds can be a force for good in this area. Creating a well thought out, coherent SIP that takes account of ESG and climate issues is an important first step.
Trustee Check List – Five Key Questions
- Am I comfortable with my current Statement of Investment Principles (SIP) and does it truly reflect my Fund’s approach to ESG factors?
- How can I ensure implementation of my ESG policy by all of my asset managers?
- How often should I discuss ESG matters with my asset managers and advisers?
- How can I independently monitor and manage my ESG policy
- Do I truly understand the ESG profile of the assets we’re currently holding? If not, what can I do about it?
- Is there any additional training required for me and the trustee board?