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UK Government changes investor duties and stewardship rules to include ESG

Switching to more engaged asset managers “should improve returns” says pensions minister

The UK’s Department of Work and Pensions (DWP) has confirmed that it will update regulation around fiduciary duty to clarify that trustees must consider financially material ESG risks and opportunities, namechecking climate change.
In a report published today, the country’s Minister for Pensions and Financial Inclusion, Guy Opperman, said results from a public consultation – which closed in July – showed major support for the amendments, which will make explicit trustees’ obligation to consider all material issues, “whether those are traditional, such as company performance, interest or exchange rates; or broader such as those resulting from ESG considerations including climate change”.
89 experts and organisations responded to the consultation, including a number of public pension pools, the Church of England Pensions Board, and corporate schemes such as British Airways Pensions, BT Pension Scheme and HSBC Bank Pension Trust. Asset managers to respond included Hermes, Legal & General and Schroders, as well as Mercer, the London Stock Exchange Group, the Pensions Management Institute and the Green Finance Initiative.
In addition to the responses, nearly 3,500 individual pension scheme members completed a questionnaire.
The changes focus on the responsibility of trust-based pension funds – currently the majority of schemes in the UK – to understand the financial implications of ESG issues, and not view them exclusively as matters of “personal ethics, or optional extras”.
“This is about the hard-headed fact that – given the time horizons of pension saving – broader considerations are likely to present long-term financial risks and opportunities to the solvency of DB schemes and the value of members’ DC pensions,” Opperman summarised.
Smaller UK schemes may have more limited options in respect of handling ESG issues, he conceded, “but even where the range of actions is as narrow as switching between asset managers or between funds, trustees have a crucial role to play. Choosing a manager who can demonstrate high quality engagement, who partners effectively with co-investors and who votes accordingly where they see poor or questionable practices should improve returns for all”.
As a result of the changes, relevant pension funds will have until next October to update their main and – where applicable – default Statements of Investment Principles (SIP) to include:

  1. How they take account of financially-material considerations, including (but not limited to) those arising from ESG considerations, including climate change;
  2. Their policies in relation to the stewardship of investments, including engagement with investee firms and the exercise of the voting rights associated with the investment.

This SIP will have to be published and circulated to scheme members annually, and eligible pension funds will have another year (until October 2020) before they have to explain how they implemented what they state in their SIPs.Notably, the explicit reference to ‘climate change’ was retained in the final amendments, contrary to requests from the Pensions & Lifetime Savings Association and others suggesting that specifically referencing it would be inappropriate.
Fergus Moffatt, who heads up policy at the UK Sustainable Investment Forum, said it was a welcome decision, because of climate change’s “cross-cutting and systemic nature”.
“This will help to focus trustee minds and remove any lingering doubt that it should be taken into account in the investment process”, he told RI, adding that “the new rules go a long way towards putting the financial services sector on a much more sustainable footing”.
Some clarifications were made to the proposals in relation to timeframes, “to make it clear that it applies to considerations over the appropriate time horizon for the scheme and its members”. This replaced a strong focus on long-term risks in the original recommendations, which some argued could overshadow the need to consider shorter-term ESG implications.
The original proposals also included rules that by next October eligible schemes must “prepare a separate ‘statement on member’s views’, setting out how they will take account of the views which, in their opinion, members hold, in relation to the matters covered in the SIP.” However, this was dropped from the final regulatory changes, and replaced with an optional policy.
“It was not our intention to give the impression in our original consultation proposals that trustees must survey pension scheme members or must act on members’ views about how their scheme is invested,” Opperman said. However, he added, it is “appropriate for trustees to take account of members’ views in certain circumstances.”
“Where the concerns are not financially material – for example, primarily ethical – trustees are only permitted to take these concerns into account when there is a broad consensus. Where an investment issue is contested, as divestment from fossil fuels or from some regimes will generally be, the trustees should focus exclusively on financially material risks and opportunities, rather than seek to weigh up the relative strengths of views”.
There had been some suggestion that pension schemes should also be required to devise a policy on impact investing, but the consultation results supported the Government’s original view that “at the present time could be confusing and counter-productive”. As a result, it too will remain voluntary.
Opperman stressed that despite the changes, “it remains [UK] Government policy not to direct the investment decisions or strategies of trustees of pension schemes. We will never exhort or direct private-sector schemes to invest in a particular way. Trustees have absolute primacy in this area.”
RI understands that a similar consultation will take place in the spring, focusing on non-trust-based pension schemes in the UK, which are overseen by the Financial Conduct Authority (FCA), not the DWP.
“These regulations are a big step forward in shifting the culture and practice of the UK pensions sector,” said Catherine Howarth, CEO of ShareAction. “It is now over to the FCA to ensure savers in schemes it regulates are given similar information and protection”.