Op-Ed: Rob Lake – sustainability, pensions and Lamborghinis

The shift to contract-based pensions poses issues for fiduciary duty and ESG.

The UK is an interesting place to be just now if you’re interested in pensions in general, and pensions and sustainability in particular; and even more so if you have a geeky interest in pension governance.
First, from April this year defined contribution (DC) pension savers will be able to withdraw the whole of their pension pot in a single lump sum at age 55, and, as the Pensions Minister famously quipped, blow it on a Lamborghini if they want to! Full disclosure: I’ll qualify for the option, but sports cars would be bad for my ESG credentials – and anyway I don’t like them.
More directly relevant to the sustainability and responsible investment worlds are the recent Law Commission report on fiduciary duty and the Financial Conduct Authority’s (FCA) new rules on the governance of contract-based DC pensions. The Law Commission stated clearly that pension trustees should take financially material ESG factors into account; must weigh return against long-term risks; and may make decisions intended to protect the portfolio as a whole by seeking to prevent ‘damage to the wider economy’. These are big steps forward. The last two conclusions are particularly significant given the long-term economic and financial implications of climate change and other sustainability challenges such as resource scarcity. The implications of the Law Commission’s guidance have yet to be properly explored; but it could spark new levels of interest in sustainability issues on the part of pension trustees and their advisors.
This is all reassuring for members of pension funds governed by trustees subject to fiduciary duty.
However, in the UK at least, increasing volumes of pension savings are going into ‘contract-based’ pensions: schemes run by insurance companies onbehalf of employers, where the legal form is a contract between the company and the saver, not a trust with the fiduciary protections that this brings. The insurance company’s primary duty is to its shareholders – which might or might not be aligned with the pension saver’s interests. Recognising this, the government has introduced a requirement for pensions of this kind to have Independent Governance Committees (IGCs), which will have a duty to act in members’ interests. The rules stipulate that IGCs’ primary focus must be on the value for money offered by the pension. Clearly this is hugely important, given the controversies that continue to rage over high costs and lack of transparency in the pension market. However, IGCs will not be required to examine how ESG or long-term risks like climate change are addressed in the default or other investment options offered to scheme members, or to look at how the scheme’s investment managers take account of the interests of the ‘wider economy’ that might affect the saver’s long-term returns and retirement income. This looks like an unfortunate failure to ensure that the same newly ESG-sensitive standards of protection apply to all pension savers, not just those in trust-based schemes. On the other hand, it could represent a chance for enlightened pension providers to demonstrate their understanding of the long-term financial implications of sustainability – not to mention their customers’ interest in these issues – by including ESG/RI in their IGCs’ remit. Most of the leading contract-based pension providers are members of PRI and the UK Sustainable Investment and Finance Association. I wonder who will be the first to seize this opportunity?

I’d be very interested to receive feedback on how sustainability is addressed in pension governance structures in other markets. Contact me at rob.lake@roblakeadvisors.co.uk

Rob Lake is an Independent Responsible Investment Advisor