Pensions and ESG

Environmental, social and governance (ESG) is increasingly in the spotlight, with issues such as climate change, diversity, and single-use plastics making headlines.
Download the policy paper

Legislation introduced in October 2019 requires pension scheme trustees to set out their policy on how they take account of financially material factors - including ESG considerations - in their investment decision making.

The policy paper from Steve Webb – co-authored by law firm Herbert Smith Freehills – takes a closer look at:

  • Responsible investment and ESG
  • How ESG impacts returns
  • How climate change factors into investments 
  • The risks trustees face if they don’t embrace ESG issues
  • How to comply with legislative changes

Discussing the issues

Steve Webb also sat down with Corporate Adviser’s John Greenwood alongside Tim Smith, Professional Support Lawyer at Herbert Smith Freehills, and Ashley Hamilton Claxton, Head of Responsible Investment at Royal London Asset Management (RLAM), to discuss what ESG means for defined contribution pension schemes.

John Greenwood – Environmental, social and governance issues are moving up the agenda for pension trustees, advisers, providers and asset managers, driven by a host of legal and regulatory changes.

Here to help us find our way through the numerous ESG initiatives that are about to change workplace pensions are Steve Webb, Director of Policy at Royal London, Tim Smith, Professional Support Lawyer at Herbert Smith Freehills, and Ashley Hamilton Claxton, Head of Responsible Investment at Royal London Asset Management. 

Steve, Royal London’s publishing a guide to ESG and what it means for pensions. Why now?

Steve Webb - One of the things that we find as an asset manager, as a company that works with employers and advisers, is that people are baffled. They don’t know what the new rules are – there are new rules coming out on the 1st October – who are they going to affect, and what do they mean?  

We’ve partnered with our friends at Herbert Smith Freehills to try and navigate the minefield of what you have to do, what you maybe should do and could do, and also what does this mean for your money - is this actually just a passing fad, is this greenwash, or is this actually an opportunity to give better pensions and better engagement?

We thought as a mutual organisation with a heritage, bringing in the Co-Op Investment team as we did a few years ago, we’re expanding our own team looking at ESG issues, this was the time for publication for us.

John – Okay, Tim, there’s a lot going on there in terms of regulatory and legal changes, can you give us an overview of what’s actually happening?

Tim Smith – Yes, from the 1 October there are some significant changes coming in for trustees of pension funds. For the first time they’re going to need to set out what their policy is on taking account of financial factors including environmental, social, governance factors in their investment decision making. Climate change has been singled out within the regulations as a particular issue that trustees have to have regard to, and they’re also going to need to set out their policy to the extent they have one of how they take into account member’s views and other non-financial considerations.

So, significant changes coming down the tracks.

We’re also seeing activity from the FCA, they’re proposing similar changes for pension providers, and also changes coming in that will affect asset managers as well.

John – You mentioned climate change there as a specific issue. Why has it been singled out?

Tim – I think probably for political reasons, largely. We’ve obviously had the Paris Accord and I think governments want to be seen to be taking action on that particular issue, and that is something that trustees clearly do need to have regard to.  

There’s increasing pressure from activist groups and others to see that pension firms are taking that seriously. I think an important issue for trustees though is that they don’t just focus on that, it’s one among a number of issues that come under the ESG bucket. Trustees need to make sure that they’re considering them across the board. 

John – Ashley if I can ask you about the E, S and the G and how they’re actually implemented?

Ashley Hamilton Claxton - Yeah. There are a lot of different ways they can be implemented so it is a little bit of a “buyer beware” market. You can go to a provider that takes a very light touch approach - that might focus mostly on voting their shares at AGMs and engaging with company management, or you can go to a much more active or activist approach where it’s very, very much about integrating environmental, social, governance factors into the financial decision making.

The regulatory changes and the signal they’re giving to the market is that now all trustees, all asset managers need to consider the financial implications of ESG. But the way that asset managers do that can be very, very different.

John – Yes, and there’s also differences in the way they use research and the ratings that different companies will get, that’s quite a complex new area isn’t it?

Ashley – It is a complex new area. Responsible investing has been around for 20 plus years, probably even longer really if you go back to the Quakers for example, who were some of the first ethical investors.

I think because it’s a new market, because there’s lots of innovation happening,  there’s lots of new fund launches, there’s lots of new research people out there, there’s lots happening with data, big data, ‘A.I.’ which is a buzzword. How do you get all of this information and use what were classed as non-financial factors previously to make better smarter investment decisions considering the environmental, social and governance factors?  

You can have different data providers – there are three, four or five out in the market – and they might all give you a different view on a company. They might say TESLA is a great company because it’s got electric cars, they may say TESLA’s a bad company because it’s got poor governance. My view is actually none of that matters – all that matters is that we asset managers are considering all of those factors and making a really informed decision for our clients.

John – Right, let’s come back to you Steve. There are a lot of misconceptions, there are a lot of things people think ESG is and then it isn’t. How would you untangle the reality is of ESG?

Steve – I think there’s a lot of different language used, a lot of different adjectives. Is it ethical, is it impact, is it sustainable, and so on. I think what’s interesting from the conversation we’ve had so far is the way that this has moved from being a non-financial thing. It’s gone from being something good people do to actually being integral to risk management and financial issues.

I almost turn the question round – if you’re investing my money, why would I want my money invested in a company that’s not well governed, that’s damaging the environment, that has a negative social impact? Because in the long run, the evidence seems to be that it’s not going to be good for my money. This isn’t just a nice to have; increasingly this has to be integrated.

John – In terms of the risk trustees face if they don’t embrace ESG issues?

Tim – I think there are a number of risks. I think one of the things we are seeing is a growing risk of legal challenge in this space.

So in Australia, a member of a large pension fund has taken the fund to court over the fact they’re not taking or being seen to be taking climate change seriously enough. In the UK, Client Earth have put large pension funds on notice that they will support members in bringing claims and legal action if they’re not seen to be taking issues such as climate change seriously. I think there is a growing risk there.

There’s also reputational issues, both for the scheme but also sponsors. If sponsors are seen to be taking a stand on issues and then their scheme isn’t, or is taking a different approach, that can cause real damage to the sponsoring employer’s reputation. That’s something as well that trustees, advisers need to have regard to when they’re making their decisions and developing their policies.

John – The Church of England being the example of that – where they were criticising Wonga and then it turned out they were investing in it. Presumably, does that risk extend to the employer themselves as well, do they want their scheme to be associated with what might be dubious investment practices?

Tim – I think it will vary, but certainly if you talk about values-based employers, and employers that are taking a stand on issues, I think it doesn’t look good if then their pension fund is taking a completely different approach.

John – Yeah. Tim you talked there about the different issues that can form part of an ESG approach; when you’ve got a diverse population of a DC pension scheme, how do you reflect all those views? How do you make a decision?

Tim – It can be very difficult, because obviously (in a) large population, people are inevitably going to have different views. A key point to make is that the starting point here is, to the extent that ESG is financial risk, you have to take it into account.

I think that’s a common misconception – I think ESG for too long has been seen in the non-financial buckets, and that’s shifting. Where you’re talking about more non-financial factors such as member’s moral and ethical views, trustees can take those into account but they’ll need to be able to demonstrate that they do represent a large proportion of the membership’s views - perhaps through surveys or member forms, that kind of thing.

And they have to have regard for the financial impact that might have. But I think what we’re seeing and I think a key message we make in the guide is these are financial factors, you have to take them into account.

John – Sure. Then the big question, on the flip side of that is, what’s the impact on performance? Ashley, if I could ask you, what’s the position?

Ashley  – So we’ve reviewed the evidence, there’s quite a bit of academic evidence out there that’s been accumulated over the past 20 years, and it very clearly states that in the vast majority of cases, considering financially material ESG factors either has a neutral or positive impact.

So that means it will have no financial impact on your portfolio or you might get a slight positive uplift. And so we think from our perspective that it’s a prudent approach, it’s a good risk management approach and it is really good for our members.

John – Right. Steve, if I could ask you, does a well-thought-through ESG approach offer an opportunity to engage with members?

Steve – I think it does, particularly with the changing demographics of, for example, the workplace pension population. 

Automatic enrolment has brought two million under-40s into pension saving pretty much for the first time. And it’s very striking that the survey evidence is that their priorities are different. I think of my own daughter, she’s in her early twenties, she’s just started her first pension, and the first thing she looked at is, ‘where’s the money invested?’

And so I think employers  have gone past the first phase of legal obligations and auto-enrolment; they’ve picked a provider, and now they’re starting to say to providers such as us, ‘Okay, we’ve chosen you, we want our employees to be happy with the choice they’ve made – where do we go next? Where do we go for engagement?’

Because what the firm doesn’t want is the employees saying, ‘Hang on, you chose Provider A, they’re not investing my money in a particularly sustainable way.’ They don’t want challenge, they actually want the workers to feel very positive about the choice the employer’s made.

Tim – I think there is a real opportunity, just picking up on that, there is a real opportunity here to engage members. It’s a positive news story to tell for trustees and for providers. I think one thing trustees and providers need to be cautious of is not over-selling what they’re doing.

We often talk about greenwashing in the context of asset managers, and trustees need to be alert to that, but they also need to be careful they’re not greenwashing their own fund. So for example, in impact investing there’s a lot of talk about that at the moment, but if that’s just a small sliver of your fund, what’s the impact of the rest of your fund? I think trustees need to be careful they’re not overstating what they’re doing, but at the same time it is an opportunity to engage.

John – Sure. Well certainly the guide that you guys have put out is going to assist in intermediaries being able to communicate this to employers and trustees. So thank you that’s all we have time for, and thank you for watching.

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