UK government proposes greater clarity for pension funds and ESG

New rules to help trustees understand their fiduciary obligation

Proposed new regulation in the UK will give pension funds the go-ahead to adopt ESG investment policies, while making it clear that climate change should be recognised as a material financial risk.

UK pension schemes will have to include a statement on their policy with respect to ESG and other non-financial issues in their statements of investment principles. They will be expected to follow this up with an implementation report to ensure this is more than a high-level statement with no impact.

“For too long, many pension schemes have disclosed vague, high-level statements on their approach to ESG factors, and failed to report on what, if anything, they were doing to protect members from the rising investment risks of issues such as climate change,” said Bethan Livesey, head of policy at ShareAction.

“These regulatory changes will help expose negligence and neglect, and help protect savers from poorly managed risks,” she added.

The new regulations should help trustees understand their fiduciary obligation better with respect to material risks such as climate change. The consultation from the Department for Work and Pensions makes it plain climate change should be considered to pose a significant financial risk and ignoring it would in most cases be a breach of that fiduciary duty.

“These are changes in name only,” pointed out Fergus Moffatt, head of public policy at UKSIF. “These new requirements are requirements that are there anyway, trustees should be doing this anyway, this is just clarifying it in law.”

As well as articulating how they will take account of ESG considerations, in future pensions’ Statement of Investment Principles (SIPs) will have to include policies on stewardship, including engagement and voting policies.

“The publication of this consultation by DWP must be seen by the industry as a call to action in relation to environmental, social and governance factors,” said Marjorie Ngwenya, President at the Institute and Faculty of Actuaries.“Those individuals who are being automatically enrolled into a pension as they enter the workforce will be saving for decades to come and it is important that their investment managers not only think about financial returns, but also the impact those investments are having on the kind of world we will be living in by the time they come to retire.”

Trustees will have to issue a separate statement on how they will take account of members’ views, including views on ethical, social impact and present and future quality of life matters.

Although many pension fund members take no active interest in their fund’s investments, there have been a number of campaigns where members have called on pension funds to follow particular investment policies.

In particular, the question of fossil fuel divestment has exercised pensions professionals and members in recent years. The new regulation could allow pension funds to follow the wishes of their members in this, subject to a two-stage test.

First, the trustees must have good reason to believe the members would approve of a particular values-driven investment policy, and secondly that it will not be to the significant financial detriment of the fund.

This may raise questions around how trustees can be confident of the views of its members since a vocal minority might not be representative of the whole. Where there is significant disagreement within the membership body, trustees are enjoined to put the divisive issue aside and focus on financial returns.

The new regulations will cover defined benefit and defined contribution pension schemes, as well as trust-based and contract-based, although the precise details of how they may be applied will vary slightly.

Advocates of impact investment will be pleased to learn the DWP rowed back from its original intention to leave social impact investing out of the consultation. Instead, it makes it clear that investing with an explicit view to making a positive social or environmental impact is permissible subject to the same two-step test of ensuring it is in line with members’ views and will not have a major negative financial impact.