ESG is part of fiduciary duty, says new code of practice from UK Pensions Regulator

Trustees of UK pension funds should consider environmental, social and governance (ESG) factors when making investment decisions, where such factors are “financially significant”, according to a new code of practice published by The Pensions Regulator, which sets out standards for trustee boards of defined-contribution (DC) schemes.

The new guidance, published following a consultation earlier this year and UK Government approval in May, is accompanied by six ‘how-to’ guides that offer comprehensive guidance across a number of topics. The investment governance guide points out that trustees should take into account factors that are financially material to any investment’s performance – such as the effects of climate change – and that ESG and ethical factors can be included if trustees also believe them to be significant.

While it states that “the pursuit of a financial return should be your main concern”, the guide allows for non-financial issues to be considered if trustees believe scheme members share their view and there is no risk of noticeably harming the value of their investments.

Later sections of the guide also make provision for trustees to consider the long-term sustainability of their chosen investments and the importance of stewardship, though it concedes that for most pension schemes stewardship activities are likely to be undertaken by investment managers on the trustee board’s behalf.

The advice follows the Law Commission’s 2014 report into the concept of fiduciary duty, which addressed the role of ESG issues in financial decisions and the importance of good investor stewardship, as well as recommending that UK Parliament clarify the role of different financial investment regulations. The UK Government subsequently launched a consultation on implementing the recommendations, but concluded they “would not necessarily lead to greater clarity for trustees”.

Since then, The Pensions Guide has worked with several organisations – including UK SIF and ShareAction– to clarify how trustees treat their scheme’s investment, particularly with a view to ESG matters.According to Simon Howard, Chief Executive of UKSIF, the revised code of practice could represent a “huge boost” for responsible investment in the UK and is great news for trustees of DC schemes, whose updated responsibilities represent the first time the Law Commission’s 2014 recommendations have been reflected in legislation.

Howard continued: “The guide on investment governance is particularly welcome and we are pleased to see our opinions have clearly been taken on board by the regulator and at times directly reflected in the wording of the guidance.” He added that a similar review and set of guidance for defined benefit schemes would shortly follow the Pensions Regulator’s DC-specific advice.

Rachel Howarth, Policy Officer at ShareAction, called the Pension Regulator’s decision to include such guidance “extremely encouraging”, adding that pension trustees were now operating on a mandate to consider all risks that might affect the performance of their funds. The NGO also played a role in shaping the new guidance, particularly in regards to provisions for how trustees might engage pension scheme members and assess their views.

“Whilst some UK schemes already do a terrific job of listening to their members, they are few and far between,” said ShareAction’s Jonathan Hoare, Director of Policy & Investor Networks. “A truly responsible investment system looks after savers’ best interests both by considering the full range of risks that can affect their savings and by listening to people’s views. The new code is a crucial step towards the kind of system we want to see.”

In June, Responsible Investor reported that pension funds in the European Union would be forced to assess climate change and social risks under a revision to the Institutions for Occupational Retirement Provision (IORP) directive, which governs EU pension funds, following a protracted series of revisions.