Editorial: Pension funds are set to engage with issues such as climate change more than ever before, as regulatory developments and increased awareness push environmental, social and governance considerations up the agenda.
Trustees have confused ethical views with financially material considerations for decades, and this has held many of them back from engaging with ESG issues. But it is now widely accepted that failure to assess ESG risks could have disastrous consequences for pension funds as long-term investors.
Policymakers and regulators are taking action, from the government requiring trustees to publish more detailed statements of investment principles, to the Pensions Regulator’s plans to signpost to the Task Force on Climate-related Financial Disclosures.
Our cover story looks at how this progress is helping to hammer home the need to consider ESG risks. It also points to the fact that ESG can be difficult to define and measure, particularly while transparency and disclosure problems remain.
And that is just the tip of the iceberg – with experts warning that greenwashing could become more of a threat as asset owner demand for products to manage climate risk rises.
While trustee understanding is improving, many do not have the expertise to spot a greenwasher. They will rely heavily on their advisers, so it is crucial that they ask the right questions to make sure they know exactly what it is they are investing in.
As Sackers’ Stuart O’Brien points out, this means that “trustees need to have high conviction in their consultants’ ESG credentials to ensure they are asking the challenging questions of their manager”.
Independent governance committees will not be exempt from tightening ESG regulations. The Financial Conduct Authority proposed a new IGC duty in April to oversee firm’s policies on ESG issues, stewardship and consumer concerns.
Writing this month for Pensions Expert, Henry Tapper argues: “If you want ESG as standard, then you will have to wait until one of the providers has the guts to move to a responsibly invested default.” (See page 17.)
So far, only a handful of defined contribution schemes have done so – from HSBC introducing a fund with a climate tilt for its DC default option, to Legal & General Mastertrust updating its default investment strategy to take account of ESG risk.
The question is how long it will take for this change to trickle down from larger schemes such as master trusts to small and medium-sized DC plans. As Mr Tapper puts it, ESG currently comes as an extra – “a bit like furry dice in your car”.
Another type of investing that is yet to become mainstream in DC pension plans involves illiquid assets. Costs, liquidity concerns, daily pricing and trading are often seen as barriers to gaining exposure to illiquids such as infrastructure and property.
The Visa Europe Pension Plan, however, is ahead of the game (page 36), with investments in direct and listed property as part of a recently introduced white-labelled fund.
While schemes must keep a close eye on costs, private and direct investments can add significant value to defaults over the long term, according to Mercer’s Maria Nazarova-Doyle.
Depending on whether the government goes ahead with its proposal to require big DC schemes to document and publish their policies on investment in illiquid assets, we could see more cases like this in the near future.
