The Pensions Regulator (TPR) issued important investment guidance for defined benefit (DB) schemes on 30th March. It runs to more than 50 pages and so I will focus on what matters on stewardship and investment. TPR has previously given guidance to DC trustees in July 2016 and this guidance follows that closely, but there are some important signs of evolving thinking and the examples and language used are interesting. As we head into the second quarter client reporting season there is an excellent opportunity to brief owners.
The Regulator’s views on stewardship have been clear since the DC guide and little has changed. TPR still links to the Stewardship Code and to sites run by the PRI, AMNT and ShareAction, but there is one interesting addition.
In the DC guide TPR suggested that trustees might ask managers three questions: who is their proxy voting adviser, how often does the manager’s vote vary from the adviser’s views, and are there any instances where votes weren’t cast.
A fourth suggested question appears in this guide: “Can they provide voting records?” This may show developing thinking at TPR and perhaps it reflects owner complaints. It may indicate the level of service TPR thinks should be offered.
(It is also evidence for UKSIF’s view, which we put to the Financial Conduct Authority (FCA) in the recent asset management market study, that the demands on managers are increasing. Our view is that the FCA should not be looking at fees when the level of service expected by such an important actor as TPR is demonstrably evolving.)
The meat of the guidance from a responsible investing viewpoint is in this section and again the evolution is important, this time in wording.
In 2014 the Law Commission said schemes “should” consider financially material factors and that ESG might be material. In 2016 the DC guide also said “should”.
This new guidance goes further, it says “You are required to take into account factors that are financially material to investment performance” and in a box headed “What you need to do” it says: “Take ESG factors into account if you believe they are financially significant”.
To my mind “required” is a definite firming of the message previously transmitted by “should” whilst the new “need” box with its imperative is also moving us away from the optionality of “should”.
Let’s be clear: UKSIF welcomed “should” in 2014 and 2016, but “required” and “need to” are much better. I think we are seeing growing confidence in TPR in the robustness of the Law Commission thinking, and below we mention other regulatory areas where this may be happening.
The thrust of TPR thinking may be confirmed by some of the examples given to help with implementation. In terms of investment beliefs TPR gives seven examples; three link clearly to responsible investment, citing corporate governance, climate risk and engagement as issues. These three stand alongside other examples on such fundamentals as rewarded and unrewarded risk, and market (in)efficiency. RI elements are here being shown as illustrative fundamental beliefs for trustees- not ‘nice to haves’.Last year Andrew Warwick-Thomson, TPR Executive Director for Regulatory Policy said “..with regards to ESG our guidance is clear that we expect [DC] trustees to take ESG issues into account when assessing portfolios over the long term.” And it is perhaps no surprise therefore that the example topic chosen to illustrate consideration of financial factors is from the RI space, namely climate risk. On this extremely important topic TPR provides trustees with example language that is comprehensive and good and will (hopefully) be quoted in the briefings to trustees from managers and advisers which should follow.
There is an example belief:
‘As long-term investors, we believe climate risk has the potential to significantly affect the value of our investments.’
And a steer on what trustees with that view should do and say:
“[The trustees] develop this belief in the SIP [Statement of Investment Principles] as follows:
• We expect fund managers to have integrated climate risk into their risk analysis and investment process.
• We will try to ensure that we manage all new and existing investment arrangements in a way that takes account of climate risk.
• In monitoring the performance of our fund managers, we will also regularly consider how they are performing with reference to climate risk issues.
In addition, the trustees decide to report annually to members on how the climate risk policy has been applied.”
And the example ends with a learning point reminding people of the new, punchy language: “Where you consider these [issues] to be financially material you are required by law…”
This is all very encouraging. The guidance is an opportunity for RI players to contact clients with an effective brief on the issues and to show how the player can meet the evolving recommendations of TPR. People outside UKSIF and the RI world won’t be able to do that credibly so make sure this area of differentiation features in your communications.
I’ve said that TPR thinking on the Law Commission findings seems to be evolving. Separately, the thinking seems to be spreading too. New rules for the Local Government Pensions Scheme saw Law Commission thinking transposed into a legal space where fiduciary duty does not technically apply, and something which (to a non-lawyer) looks like Law Commission thinking can be seen in places in the MacCall QC opinion on charity investment from last year.
The next challenge is to encourage this spreading and take the thinking into areas regulated by the FCA. UKSIF will be making the case for it when the promised review of Independent Governance Committees (IGCs) in contract DC starts. Managing long-term risks has to be done on behalf of members of contract-based schemes and with the fundamental Law Commission thinking on fiduciary duty now being endorsed more deeply by TPR, and more widely e.g. LGPS, asking IGCs to assume that responsibility seems a logical step.
Simon Howard is CEO of UKSIF – The UK Sustainable Investment and Finance Association.