Yesterday brought significant news for responsible investment in the UK with the final Government response to the 2017 Law Commission review on pension funds and social investment. There is also a linked DWP consultation on trustee duties.
The key points are:
Pending the outcome of the consultation, all trust-based pension schemes need to do a new statement of investment principles (SIP) by October 2019 that must:
• state their policy in relation to financially material factors “including but not limited to ESG considerations (including climate change)”;
• state their policies on voting and engagement with investee firms, fund managers and other investors; and
• funds have to outline the extent to which member views are taken into account “including but not limited to ethical, social impact and present and future quality of life matters”
The DWP clearly expect the vast majority of funds to be considering ESG as a result since they say in the consultation that they expect exceptions to be “limited and focused on very particular circumstances- for example imminent wind-up”.
There is also very welcome news for contract-based pension schemes. The FCA has accepted the broad thrust of the Law Commission’s thinking that contract schemes should be considering financially material factors, stewardship and members’ views. It is planning a consultation on how the regulation of Independent Governance Committees – think trustees in contract schemes- is updated to deliver this in Q1 2019.
The FCA is a bit late to this party, the Pensions Regulator first issued guidance on “financial materiality” in 2016 but let’s welcome yesterday’s development. There are signs that the FCA does see some of the broader opportunities in better pensions. They say of the likely changes that “This may increase competition between providers to design and monitor investment strategies incorporating ESG factors and protect consumers from potentially unsuitable investments.” UKSIF certainly hopes that the ESG quality of a pension scheme may become a factor in how employers are seen by the millennial auto-enrolled generation.
So this is all good, what will change?
SIPs/IGC regulations. Our view is that these are significant developments; we all know that not enough funds pay attention to responsible investment. For the past 5 years, we and others have been pushing for regulatory change in order to compel that attention, and we have now achieved that. This is a great opportunity for everyone in responsible investment. The 16 consultancy firms that signed the UKSIF/AMNT statement pledging to promote the TPR guidance in this area will now have a following wind (gale?) as they put the matter on the trustee agenda and point to a commitment across the UK legal and regulatory structure with DWP, FCA, TPR are all now using the same hymn sheet. Fund managers will need to show expertise (and experience?). It should be good for the good firms. Similar considerations should influence the IGC value and advice chain. Frankly, it will be a foolish pension scheme- trust-based or contract-based- that does not implement sensible policies in the ESG area.There are also new requirements on reporting how the policies are implemented which DWP sees as a key tool to getting rid of the “generic” SIPs which they say are currently a problem.
Member views. One reason why a scheme would be foolish to ignore what is happening is the weight to be given to member views. Our polling for Good Money Week confirms what other polls show, namely that people want their pensions invested “well”. Trust-based schemes are now to say how member views are considered in drafting the SIP; for contract-based schemes, IGCs will be required “to report on their firm’s policy on how they take member concerns into account”. The methods by which member views are to be considered are left unclear, and the core legal aspect that following the views should not involve “a significant financial detriment” is confirmed so there will be limits on what members may get. The DWP consultation clearly envisages the possibility of trust-based schemes surveying members; elsewhere it says “using broad public opinion” or treaties ratified by the UK would be appropriate and they cite cluster bombs as an instance of the latter. It’s also worth noting that the draft regulation includes the word “ethical” in this section. We suspect this area will attract a lot of comment- and perhaps controversy.
This is a great opportunity for everyone in responsible investment.
Definitions. The proposals go out of their way to say they are focused on ”financially material” issues and not “just” ESG:
“We are not proposing to exclusively refer to ESG, including climate change. We do not want to be too prescriptive and industry terminologies, in time, may change. Future systemic risks may also not be readily compartmentalised into one or more aspects of ESG.”
Whilst PRI wording is cited to give examples of ESG issues, there is no attempt to define those issues. Importantly, and very welcome, it is recognised that ESG can have positive impacts. This seems to us a sensible approach-our sector can move quickly and we don’t want to be tied down or limited by wording. How this will sit with the current EU proposals remains to be seen. There is an awful lot of paper flying about both sides of the channel. The EU document on investor duties seems to say that a business is “sustainable” if it has good governance irrespective of what it does! The proposed UK approach feels better for our market.
Stewardship. The language on stewardship is interesting. In the consultation, the DWP says it expects all schemes that are required to have a SIP to have a policy on stewardship. The language shows it is expected to go beyond voting and it gently alludes to the issue of voting in pooled funds. It is a bit softly-softly, but as schemes look at what they need to do in ESG, stewardship is bound to get increased attention.
So overall, a good day for responsible investment. It isn’t perfect- couldn’t the FCA move before 2019? And the Government has decided not to do anything legislative in respect of “social impact” investing, beyond the permissive elements implicit in member views and the need to consider ESG factors- but on balance, with the changes to regulation ESG will advance.
Simon Howard is CEO of UKSIF.