UK considers amending regulations to include non-financial concerns into investment principles

Government looking to “empower” trustees on ESG

The UK government has said it is ‘minded’ to change pension regulations to require scheme trustees to outline their policy on non-financial concerns in their Statement of Investment Principles (SIPs).

In a move welcomed by the sustainable investment sector, the government said it supports the Law Commission’s view that trustees should consider members’ ethical and other concerns, and may respond by acting on them where they have good reason to think members share the concern and it does not involve a risk of significant financial detriment. 

The news came in an interim government response to the Law Commission’s report into pension funds and social investment.

The government places its comments in the broader context of sustainable investment: the Taskforce on Climate-related Financial Disclosures (TCFD) and the EU’s Institutions for Occupational Retirement Provision (IORP) directive, Shareholder Rights Directive and the High-Level Expert Group.

UKSIF, the UK Sustainable Investment and Finance Association, called it “another important step towards more robust investment strategies which consider financially material environmental, social and governance factors”.

The government said there was evidence that trustees are not aware either of the ability to take into account non-financially material matters, or the requirement to take into account environmental, social and governance risks where there are financially material concerns.

The government, however, is stressing that the new rules won’t support “boycotts of certain countries or disinvestment from certain assets” – although it did say that “mainstream” financial services firms are responding to “unmet demand” from individual investors by increasing their offering of social impact products as well as integrating ESG and social impact concerns into their core business.

Environmental law firm ClientEarth said ESG factors are often financially material but that “many trustees understand these two concepts to be mutually exclusive”.Welcoming the government’s comments, it said: “Explicit clarification in UK pensions law of trustees’ duty to assess ESG factors – where these are financially material – will sweep confusion over climate risk off the table.”

Trade body the Pensions and Lifetime Savings Association (PLSA) – which published its own guidance on climate change this month – called it a “welcome proposal” that would clarify the expectations of pension funds.

Catherine Howarth, Chief Executive of ShareAction, says: “ShareAction has been campaigning for change in this area for years. The government’s decision to propose these reforms is a welcome breakthrough.”

Perhaps the most interesting feature of the government response comes in the annex (p.25), which provides illustrations of the possible impacts of the regulatory change, if it goes through.

Post regulatory change it is hoped that trustees will have a “clear policy around long-term financially material ESG risks, stewardship and members’ ethical concerns”.

And that they will be “empowered to raise these issues with their investment managers when looking at their advice and to appoint managers based on the evidenced consideration of longer time horizons for investment decisions”.

Without regulatory change, the government says, trustees will continue to see ESG as a “distraction” and potentially detrimental – while their fund managers would “continue to be assessed on a quarterly basis and take a short-term approach to investing”.

The illustration also extends to examples of how trustees may respond to potential environmental, social and governance issues. That could be making an investment in a water network, or a company that performs well in terms of the Living Wage or tackling “dubious practices” at a company. Under the new rules, trustees will be able to look at these issues with a long-term focus.

The government will provide a full response to the Law Commission’s report by June 2018.