On the go: Accounting for Sustainability and the Employer Covenant Practitioners Association have teamed up to launch a ‘top tips’ guide for considering environmental, social and governance risk in the employer covenant process, hailed by the Pensions Regulator chair Sarah Smart as “an important first port of call for trustees”.

The guide lays out a six-step process for embedding ESG considerations in the covenant process, beginning with defining "the relevant time horizon”, which entails trustees developing a timeframe in which to understand and assess ESG-related risks.

As examples, the guide cites “transitional risks to the energy industry” as short-term risks, while “physical risks to the agricultural industry” may take longer to materialise.

Different time horizons typically require different levels and categories of support from sponsors, it explaines. Recovery plans, which are typically judged on a six-year timeframe, may necessitate cash support from the sponsor, while long-term funding objectives over 10-15 years may require financial capacity to support downside risk, and solvency support can be required over periods of 30-40 years from the last retirement date.

The guide also recommends that trustees “broaden [their] understanding of sponsor-related risks and opportunities”.

They should begin at a macro level by applying a “sector lens” that can account for the different risks and opportunities present across the economy, then applying a “market regional lens” that can spot the different impacts of ESG concerns across regions, and then identifying “sponsor-level exposure to identified risks and opportunities”.

Furthermore, the guide contains advice on best practice when researching risk and opportunities, such as gathering relevant data and information, and engaging with sponsors and peers. It also suggests how expert advice can be leveraged to assess the potential impact of ESG considerations, such as by hiring external covenant specialists.

Trustees are also encouraged to engage with their scheme sponsors in “evidence-based discussions” to “understand how material risks will be mitigated”, such as through workshops and strategy sessions, while the final set of recommendations concerns measuring, monitoring and reassessing relevant risks and the changing impacts they may have.

Writing in the foreword to the guide, Smart hailed the “practical, simple steps” laid out therein, which she said would help trustees of defined benefit schemes “to follow, to understand more fully the risks presented to the scheme’s employer covenant”.

“I recall having discussions on the impact of [ESG] risks to pension schemes when I first became a professional trustee back in 2005. At that time many of my peers in the (much smaller) professional trustee sphere had not even heard of terms like ESG or [UN Principles for Responsible Investment],” she said. 

“Roll forward 17 years and I am pleased that the risks presented to pension schemes by climate change and other ESG factors are widely acknowledged.”

Smart reiterated TPR’s commitment to ensuring that ESG risks posed to pension schemes “are properly understood and mitigated”, with trustees serving as the “first line of defence”.

“We appreciate that understanding and addressing the multi-faceted nature of ESG risks — particularly those presented by climate change — can be daunting for trustees,” she continued.

“This guide provides an important first port of call to help trustees understand the ESG risks presented to the employer of the scheme.

“Building on this understanding, trustees will be better able to develop appropriate funding and investment strategies to manage or mitigate the potential impact of these risks on the employer covenant.”

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