The government is to consult on whether trustees should be required to state their policies on sustainability, member concerns and stewardship, and will clarify current legislation as part of a wider push to increase pension investment in social and illiquid assets.
The question on whether and how pension trustees can take into account non-financial concerns in their scheme investments has long been debated.
I don’t think what they’re proposing will necessarily be a sea change in what the law actually is for trustees
Ralph McClelland, Sackers
It is also getting fresh impetus from new EU requirements under the revised Institutions for Occupational Retirement Provision Directive, adopted last year and due to be implemented in just over a year’s time.
This latest policy announcement takes the form of an interim response to the UK Law Commission's June report on ‘Pension Funds and Social Investment’, and confirms the government's intention to follow its recommendations. A full response will follow in summer 2018.
The Law Commission report found that many barriers to social investments are structural and behavioural rather than regulatory. It repeated recommendations for reform already identified in its 2014 report on the ‘Fiduciary Duties of Investment Intermediaries’.
For trust-based schemes, the Occupational Pension Schemes (Investment) Regulations 2005 should be amended to clarify the distinction between financial and non-financial factors, and to require trustees to state their ESG policy. They will also have to disclose their stewardship policy in the statement of investment principles, the commission said.
For the contract-based universe, the commission recommended that the Financial Conduct Authority require independent governance committees to report on a firm’s policies in relation to evaluating the long-term risks of an investment, considering members’ ethical and other concerns, and to stewardship.
The Law Commission also suggested options for reform ranging from investments in charities and community interest companies to engagement.
The government said it welcomed the policy proposals and is “minded to make the proposed changes, subject to consultation with stakeholders”.
Are boards too pale, male and stale?
Richard Butcher, managing director of professional trustee company PTL and chair of the Pensions and Lifetime Savings Association, said the recommendations were a good idea in principle.
As pension funds are long-term institutions, “trustees should obviously have an eye on long-term risk and long-term potential”, he said.
But he added that there were some challenges. “The fundamental problem we have to try and overcome… is the ‘social investment is for hippies’-type approach, which still exists to a degree. The only way to overcome this is by making trustee boards more diverse,” he said.
The other issue that still stops environmental, social and governance issues from being considered, according to Butcher, is a focus on the short term when it comes to investments.
“We are almost always encouraged to behave in a short-term way,” he said, adding that consultants were to blame for this as much as trustees.
Proposals not a ‘sea change’
Partner at law firm Sackers Ralph McClelland welcomed the proposal to change the language in legislation so there is a clear distinction between financial factors of an ESG nature and non-financial factors based on ethical considerations.
However, he said, “I don’t think what they’re proposing will necessarily be a sea change in what the law actually is for trustees” regarding their fiduciary duties to members or society.
Although “there is a disconnect between what the law says and the behaviours displayed at the moment”, the proposed changes are not likely to alter these; instead, the main shift will be in how trustees’ approach is documented, he said.
McClelland advised that trustees argue the financial benefits of an investment decision rather than its ethical side, giving the example of tobacco companies.
This was echoed by Nick Buckland, senior investment consultant at JLT Employee Benefits.
“Any type of socially responsible risk is just a risk that should be considered,” he said, noting that by taking an ethical view on a particular investment it would be difficult to decide where in the supply chain of an unethical business to stop divesting.
Buckland said the proposals are in line with the rules that LGPS funds have to adhere to.
He said there is a “stronger perspective on responsible investment within LGPS. Not every fund is proactive but all funds within LGPS since last April have had to explain what their view is”.
Private sector schemes could form shareholder group
While Butcher said that not all schemes will know how to exercise their voting rights, Buckland said he did not think this was a major problem.
“It’s fairly straightforward,” he said. He admitted that “it becomes more tricky if you invest through pooled funds, but there are ways of doing it, [there are] companies that will help you engage”.
Private sector schemes should increase shareholder power by clubbing together, he said, giving the example of the Local Authority Pension Fund Forum, which works to form a collective view from its members and collaborates with larger investors to influence companies.
