Hugh Wheelan: Between corporates and their pension funds there’s a world of difference on ESG

A recent event debated the link – or lack thereof – between the sustainability strategies of sponsors and their pension plans.

I attended a fascinating discussion recently on the subject of whether the increasing ESG business activities of corporations mean the treasury departments and pension funds of the same companies should be investing their assets more sustainably? Does one rationally lead to the other?
The people and companies involved must remain nameless as the event was held under the Chatham House rule.
The topic may not be particularly new, but it is moving forward significantly. Here’s my ‘anonymous’ report of the discussion.
The Finance Director (FD):
…of a large corporate told the event that the business models that have been used for growth to date will not work in the future. The FD said risk issues such as licence to operate, resource efficiency, supply security and consumer costs for resources like water and waste were becoming increasingly important, especially in emerging markets. For the company, a large part of its own water/waste footprint was consumer use of its products. Sustainability is therefore a consumer imperative, and one of the company’s drivers for long-term growth. It is also a recruitment bonus and driver of ideas.
The FD said the company’s involvement as a first-mover in issuing a green bond was part of its desire to demonstrate how ESG issues can be financial.
The pension fund Global Chief Investment Officer:
….at the same company said that while the company’s economic rationale for sustainability made sense, many of the pension funds were de-risking from equities to bonds in order to pay out to their members, which called for a different focus. A joined-up corporate/pension fund ESG strategy, he said, helps if the company wants its pension scheme trustees to be more sustainable and long-term. The CIO noted that the company covenant (the ability of an employer to fund its pension scheme and underwrite investment risk) is key here. Long-term growth, the CIO said, is good, but pension funds need growth ‘now’ too, especially where there are deficits. The CIO also noted the company’s major shift to defined contribution (DC) plans, and asked what long-term investing vs. short-term investing means in that context.“Where is the proof statement that long-term is better? Value creation over the long-term doesn’t mean that there isn’t value creation over the short-term. There’s a need to demonstrate where/if short-term strategies are detrimental to performance, and an unpacking of the long-term discussion.”
The FD said the best companies produced both good short and long-term returns. While the company backs the move away from ‘noisy’ quarterly reporting, this shouldn’t be at the expense of transparency on the short-term numbers for the market.
The FD said there were four major challenges for the company:

  • The business case, putting numbers on ESG is difficult in areas, and it is working with other companies on this.
  • Defining what success looks like?
  • Reporting, and ESG KPIs: not many are robust enough for business purposes.
  • Internal alignment: necessary for winning the hearts and minds of management and staff.

The pension fund CIO said the four points the FD had raised were different for pension funds; notably that KPIs for the pension fund are more risk-driven.
Looking at an issue like CO2 emissions, the CIO said there was a lot more work to do on corporate KPIs, which was the right thing to do, but that it was easier for a company to do so if there was clear alignment to the financials.
The CIO said its pension schemes had come under little pressure from members on ESG issues, receiving just three letters, mostly based on a ShareAction template: “It’s an improvement though, we had none a few years back.” One important development, the CIO said, was around the pension fund covenant and actuarial valuations: the company has made sustainability a key part of its business strategy, therefore the trustees might consider that the covenant was strengthened by the business model, and actuarial valuations of the pension funds could be influenced accordingly?

The pension fund trustee
…from a different company fund, and a big ESG supporter, said major challenges for schemes these days were quite broad, and included, affordability, low carbon and shareholder returns. The trustee said an important question was how to influence the type of market and quality of world that members retire into. However, the trustee pointed to a previous UKSIF survey that showed the link was weak between sponsor and fund on sustainability. One problem, the trustee said was that the level of knowledge of trustees around the issue is remarkably low and it is still perceived as an ‘ethical’ issue. In addition, capacity for looking at ESG issues is low. Trustees are a quite a few steps removed from investee companies, so it is necessary to make the asset managers do the work.
The Corporate Sustainability Director (CSD)
…from another company said it had changed the way it selected fund managers in order to move to a more ESG informed basis in its fund management. The CSD said internal initiatives around sustainability were important to develop new thinking and development and that the company had recently created a £10m impact/energy entrepreneurship fund, of which £5m has been disbursed to eight companies with a mixed financial and social goal. The CSD said there was starting to be clear evidence of ESG performance in the business.
The commentator/governance expert
…noted a need for serious caution: “The purpose of the pension fund is not the same as the company. The former is guided by trust law for the benefit of its members only.”
The commentator said investor oversight of companies via the UK Stewardship Code was essential, noting the recent Tesco accounting/audit failure was an example of where Stewardship isn’t working. Asset managers should be upping their game to look at company business models, etc, and pension funds should be taking a much tougher line in getting them to do so,while consultants had been “woeful” in looking at Stewardship. The commentator said this oversight was the same with regards to issues such as fund manager dealing commissions, and fee structures (currently under scrutiny by the Financial Conduct Authority) which were also far too high in asset management, and little had been done about them.
The pension fund professionals
One UK pension fund said ESG issues fitted most appropriately into its asset allocation discussions, looking at mid-long term themes and asset pricing/mispricing, and potential investment futures and stress testing scenarios. But it said there was a dearth of data, and significant uncertainty on such themes and being able to look at them over time.
Another experienced pension fund professional said this kind of research needed to be managed through trust and delegation via asset managers, and said some corporate pension funds were starting to build these kinds of long-term relationships.
Another pension fund trustee said there was a strong argument that major ESG risks should be on the obligatory ‘risk register’ for UK pension funds listing major risks over the next 1-5 years. The trustee noted that the shift from defined benefit (DB) to defined contribution (DC) and contract-based insurance plans could also see ESG become a requirement for the Independent Governance Committees (IGCs) that contract-based schemes must have to have in order to act in members’ interests (see the following RI article)
The development of the discussion is interesting, but a fundamental gulf remains.
The corporates at the event spoke about growth and opportunities in sustainability.
The pension funds/investors – at best – spoke about risk management.
Between the two is, of course, a world of difference.