UK regulator ramps up ESG duties for DC funds’ governance committees

The UK’s Financial Conduct Authority (FCA) has given ESG and stewardship duties to the Independent Governance Committees (IGCs) that oversee contract-based workplace pensions.

The new responsibilities, laid out in a policy statement, are to “consider ESG considerations, member concerns and stewardship” and detail policies, concerns and provider responses in their annual reports.

"This is a growing area of the pension landscape thanks to auto-enrolment, so if firms and IGCs really respond well to these rules, this is potentially very significant"

The regulator said IGCs can “use their judgement” to decide which standards to use when reporting. It explains: “This is an area with a great deal of focus in the market. There are also standards being developed as part of the EU’s Sustainable Finance Action Plan… We need to allow ongoing EU and industry workstreams to run their course and build from these.”

It said IGCs may consider appropriate time horizons over which different ESG risks may emerge for different types of product – an amendment made in response to consultation feedback.

They must now also consider the opinions and concerns of scheme members, saying: “We want outcomes that appropriately reflect consumer concerns, while not exposing them to significant financial risk.”

How member views are to be considered are unclear.

The FCA expects the new rules could increase competition between providers to incorporate ESG factors into their investment strategies and decision-making

Ben Nelmes, Head of Public Policy at the UK Sustainable Investment and Finance Association (UKSIF), said the new rules were “potentially very significant”. 

He said: “This is a growing area of the pension landscape thanks to auto-enrolment, so if firms and IGCs really respond well to these rules, this is potentially very significant.”

“However, in the world of trust based schemes, we've seen a very mixed picture so far when trustees have had to respond to similar rules introduced about a year ago for them.”

Nelmes said getting the necessary skills and expertise would be a challenge. “I think a lot of these firms haven't thought about these issues before. The industry collectively has to up-skill.”

The FCA said in the statement that it expects that the new rules could increase competition between providers to incorporate ESG factors into their investment strategies and decision-making, which it said would “drive further improvements to how ESG factors are incorporated” over time.

The policy statement comes after the closing of a consultation on the additional duties that closed in July, which in turn came off the back of recommendations from the Law Commission. 

The rules will come into force in April 2020, therefore reports issued in early 2021 will have to take the new regulations into account.

UK trust-based workplace pension schemes have been required to publicly set out their investment policies in relation to “financially material considerations”, including climate change and other ESG factors since October 1 of this year.

A review of disclosures by the largest 16 UK master trusts – multi-employer workplace pension schemes run by either an asset manager, consultant or insurance company – has found that “the vast majority are falling short” by not engaging with portfolio companies on their role in the climate crisis.

These include master trusts administered by blue chip investment services providers such as Aon, Fidelity, Standard Life, Scottish Widows, SEI and Mercer.

According to the analysis, conducted by campaign group ShareAction, this is due to trustees “overly-delegating stewardship to their asset managers” as opposed to developing policies specific to their pension schemes.

“Without a clear mandate from the trustees, it is hard to see how this would result in best practice RI activity for the master trust and bold action on climate,” the analysis concludes.

Unlike IGCs, trustees have “absolute primacy” in relation to investment decisions and strategies according to UK government policy.

ShareAction’s report places government-backed pension scheme Nest ahead of the other master trusts analysed due to, among others, an active engagement policy with both its asset managers and portfolio companies, detailed climate change and social policies and TCFD-compliant reporting.

Meanwhile, Nest, which was the first master trust to introduce a climate tilt in its default plan, has announced that the move has resulted in the reallocation of more than £200m (€235m) away from fossil fuel-intensive companies and toward renewables over the past year. 

The fund has also revealed it is the latest signatory to campaign group Climate Action 100+ which has led a number of high-profile investor engagement activities with oil and gas majors over the past year.