Pensions and ESG podcast - Episode 1: The evolving landscape

1 October 2020

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Listen to our latest podcast which looks at the recent regulatory changes surrounding ESG.

Ashley Hamilton-Claxton, Head of Responsible Investment at Royal London Asset Management (RLAM) joins Tim Smith, Professional Support Lawyer at Herbert Smith Freehills and shares her views on:

  • How pension schemes and asset managers are responding to recent legal and regulatory changes relating to pensions and ESG.
  • Insights on how attitudes to ESG risks are being affected by Covid-19.
  • Tips on how trustees should go about preparing their new investment implementation statements.
  • Expectations for how this area is likely to develop in the coming years, and thoughts on what the DWP's proposed new requirements regarding climate-related risks would mean for trustees and asset managers.

Tim Smith:               

Welcome, everybody, to this latest podcast from the Herbert Smith Freehills pensions team.  My name's Tim Smith and today I'm very pleased to be joined by Ashley Hamilton Claxton, who's head of responsible investment at Royal London Asset Management.  Today I'm going to be discussing with Ashley some of the recent developments in relation to ESG and pensions investing and also looking ahead to how things might develop in this space in the future.  Ashley, thanks for joining us today.

Ashley Hamilton Claxton:  

Thanks for having me.

Tim Smith:               

Just wondered, perhaps could you start briefly by describing your role at Royal London and the work that you and your colleagues do for pension fund clients?

Ashley Hamilton Claxton:  

Certainly, so as you mentioned, I'm head of responsible investment.  I report into our chief investment officer, so I'm part of the front office leadership team.  Essentially we help our fund management team implement our responsible investment strategy.  That includes assisting and helping coordinate company engagement, so going to speak to companies we own about environmental, social or governance risks, ESG risks, or opportunities.  We also help implement our proxy voting across our equity funds.  We vote about 15,000, more than 15,000 resolutions every year.

We also help the fund managers think through ESG integration, so how do they integrate environmental, social and governance considerations into their investment process.  So undertaking deep dive analysis on companies or topics, coaching them through how they might want to think about climate risk within their portfolio, for example.  Then we also for some of our clients, particularly our pension clients which we're seeing an increased demand from, is help the business think about how we can assist with bespoke ESG needs for clients that have segregated funds with us, for example.

Tim Smith:               

Great and it's been a year now since we worked together to produce a report, which was looking at how things are evolving in this space.  In particular, the new requirements that came in last October for trustees to put in place written policies on financially material ESG factors.  What difference has that made in practice?

Ashley Hamilton Claxton:  

Quite a lot actually, I have to say.  People like me, who've been working in the industry for quite some time, have always said the minute we get regulations around pension trustees and the asset owners around this, we will drive change.  We are seeing that happen, which is quite a good thing I think.  So what have we seen in RLAM?  We've seen a significant increase in the number of requests for proposals for new funds, or due diligence questionnaires for existing clients that reference or ask questions around ESG.  We've seen a dramatic increase from client queries about ESG questions.

We've also seen quite a significant increase in the sophistication and detail of the questions we're getting from clients.  Not all clients, but certain clients are definitely increasing their sophistication.  So for example, we had one client questionnaire only on ESG topics which was 20 pages long, which was pretty extraordinary to be honest.  Pretty much all of our client presentations now, whether it's sales pitches or updates, do include an element of ESG and that is both being driven by RLAM but also from demand from our clients.

Tim Smith:               

It would be interesting to know - obviously the last six to nine months has been dominated by COVID-19 and the pandemic.  What impact are you seeing that having on trustees and members' attitudes towards ESG factors?

Ashley Hamilton Claxton:     

It's interesting because I think when the pandemic first was starting to happen, I think a lot of people in the RI, responsible investing, wondered whether this would actually cause a significant delay or pause to a lot of the good work that we've been doing over the last 15 to 20 years, because prior to the pandemic ESG was absolutely going mainstream.  So I think we all paused and worried whether people would shift gears to look at very, very short-term financial consequences of the pandemic. I'm actually quite pleased to say that that hasn't happened.

In fact the opposite has happened, I think COVID-19 has highlighted for people a lot of the social issues that affect us as individuals and as pension savers and shone a spotlight on that for us.  So I think actually COVID-19 has driven even more interest in this area.  In particular, even more interest in specialist funds like our sustainable funds, for example, have seen unbelievable flows of assets coming into them during the pandemic.

So I think it's been surprising but also really hopeful that that's the case, that there's been really no change.  The only change is, I think, there was a huge focus and rightly so on climate and there still is, but I would say social issues absolutely have shot up to the top of the agenda.  Particularly around things like labour standards, health and safety of workers in pandemics, but also things like diversity driven by the Black Lives Matter protests.

Tim Smith:               

Yes, that's certainly consistent with what I've heard from others, saying that there's a much bigger focus on the S in ESG now than there perhaps ever has been previously.  Obviously the thrust of last year's regulations was on financial factors and trustees needing to think about and set out how they take those into account.  Are you seeing much movement in terms of non-financial factors, such as things like moral and ethical considerations?  Are you seeing much more focus on that from schemes or members?

Ashley Hamilton Claxton:  

I think it really depends on the scheme.  I think there's been some increase in focus on that for certain schemes, where that's really, really important to their underlying beneficiaries.  There's certainly been more discussion about it and I think there's been more consultation with beneficiaries on their views around this, but I would say it's pretty mixed.  I would say, on the other side of it, there is this also trend away from things like exclusions or looking at ethical implications.

So people are thinking more about how do we integrate ESG factors, how do we think about adjusting our financial position or our investment decisions, as opposed to identifying so-called bad companies and not investing in them.  So I think there's a bit of a tension, you can see some schemes, yes, looking at ethical issues more regularly and consulting more regularly.  But then you see other schemes who are very much taking a much more financially focused approach around actually integrating ESG, as opposed to identifying a bad list of companies they won't invest in.

Tim Smith:               

Going forward, from 1 October trustees will be required to include a new implementation statement in their annual report and accounts, which really sets out what they've done around ESG, how they've implemented their policies and how they've implemented their policies on things like voting and engagement as well.  What tips do you have for trustees as they prepare these and what can they expect from their asset managers?

Ashley Hamilton Claxton: 

This has been really interesting actually.  I think we've seen a wave of requests over the last six weeks around this.  Even though we've known the regulation is coming, I don't think anyone was really thinking ahead about it sadly.  So we are getting lots of last minute requests.  We're getting lots of questions coming from our clients that are quite unclear, so it tells me that the client isn't exactly sure what they're asking for, what information they're looking for.  It does make it quite difficult for us as asset managers to then respond to those.  So it's been quite interesting over the last six weeks, I'd say.

I'd also say that a lot of their requests are uncoordinated, I suppose and also the client doesn't seem to understand the asset class they're invested in with us.  So for example, we can see we're just getting a standard list of questions.  It might ask about proxy voting, but then when we look we'll see well this client is actually in a cash fund.  So it's quite challenging, I suppose, from an asset manager's perspective to answer all of these varied client queries in a very, very short time span, when the questions are quite unclear.

So a few tips as a result of that, I suppose, I would say prepare early, absolutely prepare early.  Give yourself and us as asset managers a reasonable deadline, because even though they seem like quite simple questions, give us a list of your significant votes or something like that, the answers are not simple.  It definitely depends on what kind of fund you're in.  It also very much depends on if you're a pooled fund or in a segregated fund.  It might be much easier for us to get something on a segregated fund and it's been more tricky on a pooled fund, for example.

I would say also define your terminology.  Be really, really clear about what language you're using and what you mean by that language.  This is a consistent problem in the industry at the moment, which is everyone uses slightly different language to describe the same thing or different things.  So if clients are really clear with us about what exactly they mean by their language, then it's much easier for us to answer that.  The way we've been addressing that is actually helping define it for customers and say this is what we mean by responsible investing or ESG integration and then answering a question accordingly.

Then finally, really know your asset class in your funds.  I think if you want to genuinely do this properly you do need to have a little bit of a nuance between your equity funds and your fixed income funds, for example.  So sending standard questionnaires is quite tricky.  Then finally, I guess, maybe to call out to consultants and those that advise pension schemes, perhaps even lawyers, if you guys can help come up with some more standardised questions it's going to be much easier for us to answer those questions across 20 or 30 of our clients, as opposed to receiving 20 or 30 different requests.

Now of course, on the flipside the clients will receive many different formats from their fund managers.  So I think between us, the consultants and the clients we need to work out a more structured and probably more - a more structured way of being able to answer these queries that doesn't create lots and lots of work for everyone.  So those would be my main tips.

Tim Smith:               

It sounds like there's a real need for coordination among schemes and consultants and asset managers and as you say, need for more standardisation in this space.

Ashley Hamilton Claxton:  

I think so.  The regulator asks open-ended questions and I think they do that on purpose.  Open-ended questions can be really helpful, but equally you can end up getting not very helpful answers.  I know some of the pension consultants just I think this week have announced that they're going to start working together on responsible investing and sustainability.  So one of these things I would like to call on them to do is to help work with asset managers and their end clients to coordinate this process a little bit better.

Tim Smith:               

Yes, I think it would be important for asset managers to have a key seat at the table there.  In terms of just looking ahead say over the next three to five years, clearly a lot's already happened in this space but how do you see things developing in the years ahead?

Ashley Hamilton Claxton:  

I think luckily we've hit this tipping point, so this is now mainstream.  So we're getting less questions now about does this really matter, is it going to affect my investment returns.  I think fortunately those issues are becoming less frequent and it's now just people getting on with it.  So I think that's a huge, huge benefit.  ESG is an evolving area just by its nature, so evolving topics that could be material financial risks will always be changing.  So the future really is, for teams like mine in responsible investing within asset managers, is constantly horizon scanning for the next big fix.  Trying to identify those, trying to then assess how they'll affect our investments.

I think for pension schemes it's going to have to be really focused on really getting the best you can out of your asset managers.  So this first wave of the implementation statements, as we said, might not yield the best results because it feels quite last minute and it feels a bit uncoordinated.  So I'm hoping that by next year when we get to this time, both the asset managers and the clients have worked out what it is they exactly want.  Then we can have a bit more of a clear conversation with clients about how they want to monitor us and where we can improve.

So I think the future's looking quite good.  We are busier than ever, the demand from clients for more ESG information, more reporting, more transparency, is absolutely a positive thing.  We need to think about how we do that in a way that is value-added for our clients and doesn't increase cost significantly, because obviously keeping pension scheme costs down is really important.  So it's quite an exciting time, there's a lot of change happening, a lot of challenges still to address, but we're definitely busy. 

Tim Smith:               

Earlier you mentioned climate change and we've obviously just had a new consultation issued by DWP specifically on climate related risks.  Where they're proposing initially for large schemes but potentially ultimately for smaller schemes as well, that there’ll be new requirements for schemes to set metrics and targets around climate related issues.  Also to undertake things like scenario analysis.  On the face of it this sounds like some quite significant new requirements and quite a lot of work would be involved.  How significant do you think these proposals are and how much work would be involved in both the trustee and asset manager side, if these actually come into force?

Ashley Hamilton Claxton:  

I cautiously welcome this.  I think it is right to be focusing on climate risk, it is a significant systemic risk that can affect pension schemes.  It's not the only significant ESG systemic risk, so we need to keep that in mind.  I do worry a little bit about the data underlying this, so in order to set targets you need to know what your position is.  We have some pretty serious concerns about the breadth of data available in the market.  If you want to do, for example, a carbon footprint which is a backwards looking assessment of how much carbon your portfolio creates, or the companies in your portfolio create.

If you do that for a typical Royal London credit fund, using only a third party provider of carbon data, you get data coverage of about 40 per cent.  So that means you don't have sight of 60 per cent of your assets.  Now, I raise this flag whenever I speak to industry bodies and regulators and others, that it's absolutely great to start talking about scenario analysis and planning and thinking about these things, but we have to realise the level of data we have is very limited.  The benefit of having an internal RI team is that 

we've got experts who can actually do a lot of work behind the scenes. We're actually working on a tool where we can do almost our own carbon footprint, using our own knowledge of where we lend in the balance sheet of companies. 

So I think the data is my big challenge and I think people just don't yet know what a net zero carbon portfolio looks like.  You have to decarbonise the whole economy.  If you're a broadly invested multi-asset customer, you probably invest across the market and essentially you need to decarbonise the whole economy.  So I don't think people worked out what that is.  We can absolutely as asset managers have influence on companies and we can engage with them and we can vote.  But I would be lying if I said it wasn't going to be a challenge; I think it will be a really big challenge and the data is certainly a challenge.

Tim Smith:               

Interesting, one of the things, just picking up from what you've been saying, is I think for a long time there have been concerns around ESG that potentially are just paying lip service to it.  But it sounds like that's really changing and there's much more momentum now in this space.

Ashley Hamilton Claxton: 

There is much more momentum and there is a big, big drive to measure everything, which is actually very interesting.  So again with the DWP complication, it's about measurement.  Measurement is really, really important, but one of my favourite sayings is not everything that matters can be measured.  You feel that way about ESG, some ESG risks will just be intangible risks where it's professional judgement, as opposed to something you could measure and put down on a page.  So it's quite interesting to see this real drive for crystalising a measurement of an ESG risk, as if that's going to capture the full consequences of that risk.

I think we need to be quite careful about that to be honest. I think we still need quite a lot of professional judgement from our fund managers who, to be fair to them, have been looking at intangible risks for their whole careers and trying to put a value on that and trying to assess relative value.  So it'll be interesting, there is real drive towards measuring ESG risk.

Tim Smith:               

Great, that's really helpful. Thank you for sharing your insights with us today, Ashley.

Ashley Hamilton Claxton:  

My pleasure.

Tim Smith:               

Thank you to everyone for listening.  If you want to receive future podcasts, then make sure you subscribe to our blog.  Thanks for joining us.

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